BUSINESS  MAN 
SHOULD 


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ACCOUNTING  EVERY   BUSINESS 
MAN   SHOULD    KNOW 


Accounting  Every  Business 
Man  Should  Know 


By 
ELISHA  ELY  GARRISON 

T.IECT.-COL.    U.    8.    ORDNANCE   DEPT.,    FORMER   VICB-PRre,   COLTS   PATENT   ITOB  | 

ARMS  MTO.  CO.,   HARTFORD,    FORMER  MANAGER  SIMMONS  HDW.  CO.,   ST.   LOCIS 


Garden  City  New  York 

Doubleday,  Page  &  Company 

1920 


nsG 


r'o 


6" 


'copyright,  1009,  AND  1919,  BY 

JDOUBLEDAT,  PAGE   &  COMPANY 

ALL  RIGHTS  BESERVED,  INCLUDINO  THAT  OV 

TRANSLATION  INTO  FOREIGN  LANGUAGES,  ' 

INCLUDING  THE  SCANDINAVIAN 


TO 
THE  354  CLUB 


525S45 


CONTENTS 


CHAPTOI  MU 

I.    Origin  and  Foundation  of  Ideas   ...  8 

n.    The  Transition  to    Modern    Methods  17 

m.    The  Reorganized  Ledger  System  .     .     .  S4 

IV.    Opening  the  Ledger 45 

V.    Closing  the  Ledger 68 

VI.    Account  Characteristics 69 

Vn.    Valuation  and  Reserves 90 

Vm.     Inventory  Ledger:  Expense  and  Rev- 
enue Ledger 101 

IX.    Department       Costs    and    Contingent 

Addition 119 

X.    Fundamental      Principles      of      Cost 

Accounting 129 

XI.    Devising  of  Systems 144 

Xn.    Statement  of  Results    .     .     .     .     .     .  158 

XTTT.    Accounts  and  the  Manager     ....  169 

XrV.    Accounts  and  the  Directors    ....  179 

XV.    Dictionary  of  Accounting  and  Book- 
keeping  Terms 189 

vii 


FOREWORD 

These  ideas  are  the  accumulation  of 
twenty  years'  close  contact  with  the  subject, 
and  application  of  its  principles  to  a  great 
diversity  of  operations.  Manufacture  in 
various  lines,  Banking,  the  Football  Asso- 
ciation of  Yale  University,  Transportation 
of  live  stock  from  Texas  and  Mexico  to 
Cuba,  the  largest  Wholesale  Hardware 
House  in  this  country.  Mining  in  Arizona, 
the  Retail  .Business  in  New  York  City,  and 
Brokerage  have  all  helped. 

The  purpose  is  to  explain  away  the  ob- 
scurity which  frequently  hides  the  real 
values  and  purposes  of  accounting. 

Frequent  reiteration  is  unavoidable  be- 
cause of  the  interdependence  of  all  parts, 
and  the  bearing  of  vital  principles  upon  so 
many  different  features. 


X  Foreword 

Great  length  and  much  detail  have  been 
avoided;  but  the  average  mind,  with  no 
previous  knowledge  of  the  science  of  ac- 
counting, should  get,  from  a  careful  reading, 
a  clear  conception  of  all  the  fundamental 
principles.  E.  E.  G. 


ACCOUNTING  EVERY   BUSINESS 
MAN  SHOULD   KNOW 


»  »  » •   » 


Accounting   Every   Business 
Man  Should   Know 

CHAPTER  I 

ORIGIN    AND    FOUNDATION    IDEAS 

ACCOUNTING  is  the  science  of  so 
L  analysing  and  recording  all  incidents 
and  transactions  of  a  business,  estate,  or 
organisation,  that  results  may  be  shown, 
and  tendencies  indicated. 

The  primary  operations  of  accounting 
consist  of  the  contemporaneous  accumula- 
tion of  all  necessary  data,  classified  for  con- 
stant reference,  and  in  such  form  that  clear, 
brief,  and  accurate  statements  may  be  made 
therefrom,  at  stated  periods  (with  the  help 
of  necessary  revaluations,  or  inventories), 
for  the  purpose  of  ascertaining  past  results 
and  determining  future  policy. 

The  ultimate  operation  of  accounting  is 
the  creation  of  statements  of  results,  to- 

3 


4     Accounting  for  the  Business  Man 

gether  with  the  derivation  of  correct  deduc- 
tions  therefrom.* 

Past  events,  present  conditions  and 
tendencies,  can  be  judged  correctly  only 
through  an  intelligent  understanding  of  the 
information  furnished  by  a  suitable  account- 
ing organisation;  hence  the  importance  of 
a  knowledge  of  the  subject  to  all  in  posi- 
tions of  responsibility.  The  usual  difficulty 
in  the  way  of  mastering  its  intricacies  lies 
in  the  fact  that  so  many  business  men  fail 
to  discover  its  practical  value  until  too  late 
to  serve  an  apprenticeship  as  bookkeeper, 
and  no  other  way  seems  open. 

If,  however,  we  carefully  consider  the 
stages  by  which  the  present  science  of  ac- 
counting has  developed  from  the  first  prim- 
itive business  records,  much  of  the  mystery 
and  seeming  obscurity  disappear.  We  need 
not  go  back  to  the  use  of  tokens,  or  even 
of  hieroglyphics,  though  the  principles  are 
the  same. 

The  first  step  toward  modem  accounting 
was  the  use  of  an  ordinary  blankbook  in 

*  The  work  will  prove  more  valuable  to  those  who  memo- 
rifle  thoroughly  the  foregoing  three  paragraphs,  studying 
carefully  the  bearing  of  nearly  every  word  therein. 


Origin  and  Foundation  Ideas         5 

which  were  recorded  certain  events  for  the 
sake  of  refreshing  the  memory.  Probably 
the  class  of  transactions  appearing  most  fre- 
quently consisted  of  sales  on  credit.  This 
was  particularly  important  in  early  days 
where  money  was  slow  in  circulating,  and 
payments  were  frequently  made  in  com- 
modities at  some  later  date.  But  even  after 
a  circulating  medium  became  general  and 
plentiful,  and  settlements  began  to  be  made 
at  shorter  intervals,  a  written  record  of 
credit  sales  was  indispensable  to  the  mer- 
chant who  was  not  furnished  with  an  in- 
falUble  memory.  When  his  customers 
called  to  adjust  their  accounts,  he  went 
through  his  book  with  them,  back  to  the 
date  of  the  last  settlement,  and  totalled  up 
the  account. 

This  process  became  burdensome  and  in- 
terfered with  other  duties,  when  a  particu- 
larly long  account,  or  a  considerable  num- 
ber of  accounts,  had  to  be  made  up  during 
busy  hours.  This  led  to  the  idea  of  pro- 
curing another  book  into  which  were  copied, 
at  night,  from  the  diary  or  daybook,  those 
accounts  which  were  most  active;  each  such 


6     Accounting  for  the  Business  Man 

account  being  given  a  separate  page  in  this 
new  book.  This  was  the  origin  of  posting, 
and  the  second  book  was  the  ledger.  Mean- 
while promiscuous  transactions  and  sales  to 
infrequent  purchasers  were  recorded  as  be- 
fore, but  not  copied  or  posted.  A  part, 
only,  of  the  operations  of  a  single  class, 
appeared  in  the  ledger. 

Next  it  became  desirable  for  similar  rea- 
sons to  record  purchases  for  credit,  first 
in  the  day  book,  to  avoid  disputes,  and  then 
to  copy  certain  purchase  accounts,  in  like 
manner,  into  the  second  book  or  ledger, 
partly  because,  in  some  instances,  of  their 
frequency,  and  in  others,  because  of  the  fact 
that  certain  purchases  were  made  from  peo- 
ple or  concerns  who  already  had  sales  ac- 
counts in  the  ledger,  and  who  naturally  ex- 
pected to  have  their  credits  appear  over 
against  their  debits. 

At  this  point  it  was  necessary  to  decide 
between  debit  and  credit,  as  to  which  should 
have  the  right  and  which  the  left  side  of  the 
page.  From  all  time  left  and  anti-  have 
been  synonymous,  hence  debits  to  an  ac- 
count, or  entries  against  it,  appear  on  the 


Origin  and  Foundation  Ideas         7 

left  side.  The  reasoning  was  from  the 
standpoint  of  the  account,  not  of  the  busi- 
ness; hence  the  fact  that  things  owned,  or 
assets,  are  shown  on  the  left  in  a  balance 
sheet,  while  things  owed,  or  liabilities,  ap- 
pear on  the  right.  The  balance  sheet  is  a 
list  of  account  balances,  which  balances  are 
made  up  from  original  entries  made  from 
the  standpoint  of  the  account — the  outsider 
— not  from  the  standpoint  of  the  business. 
A  small  business  on  a  cash  basis  needs  no 
accounts  or  balance  sheet,  because  all  the 
goods  are  in  sight  on  the  shelves,  and  the 
owner  learns  to  tell,  almost  at  a  glance,  the 
value  of  his  stock,  from  time  to  time:  all 
his  money  is  in  the  drawer  and  can  be 
counted.  There  is  nothing  else  to  consider. 
But  a  larger  business,  even  though  it  con- 
tinue on  a  cash  basis,  becomes  more  of  a 
problem,  because  those  goods  in  sight  are 
more  spread  out,  and  other  goods  are  not 
yet  unpacked,  are  in  storage,  or  in  transit. 
They  may  be  overlooked  in  the  most  careful 
survey.  When  to  these  difficulties  we  add 
the  fact  that  the  cash  drawer  has  ceased  to 
represent  all  other  assets,  the  problem  be* 


8     Accounting  for  the  Business  Man 

comes  more  and  more  complicated.  The 
moment  that  sales  or  purchases  for  credit 
begin,  this  condition  arises.  The  only  evi- 
dence that  the  credit — the  good  name — of 
customers  has  come  in  in  exchange  for 
goods,  may  be  an  entry  in  one  or  both  of 
the  books  above  mentioned.  The  same  is 
true  of  that  portion  of  our  credit  or  good 
name  which  we  have  hypothecated  in  pur- 
chasing on  credit.  Nevertheless,  in  estimat- 
ing our  condition  it  would  be  inaccurate  to 
lose  sight  of  goods  sold  for  credit  and  at  the 
same  time  to  ignore  the  value  of  that  credit, 
nor  would  it  be  fair  to  include  goods  bought 
and  not  paid  for,  unless  we  offset  their 
value  by  the  amount  of  our  own  credit 
pledged. 

To  return  to  the  steps  in  the  development 
of  an  accounting  system  complete  enough  to 
take  all  these  matters  into  consideration: 
Probably  after  the  adoption  of  the  second 
book,  which  in  some  way  came  to  be  called 
a  ledger,  the  next  difficulty  arose  in  con- 
nection with  the  cash  drawer.  The  business 
has  grown  to  much  larger  proportions,  a 
partner  has  come  in  and  clerks  have  been 


Origin  and  Foundation  Ideas         S 

employed.  Several  people  now  have  access 
to  the  cash  drawer,  and  a  suspicion  arises 
that  it  is  not  treated  with  due  respect.  As 
a  means  of  settling  controversy  and,  at  the 
same  time,  of  rendering  pilfering  more  diffi- 
cult, a  third  book  is  laid  on  the  counter  just 
over  the  cash  drawer,  and  strict  orders  given 
that  a  record  shall  be  made  of  every  cent 
taken  in  or  paid  out.  Following  the  anal- 
ogy of  the  form  taken  by  those  ledger  ac- 
counts which  record  the  receipts  of  other 
people's  credit,  and  the  extensions  of  our 
own,  it  seems  perfectly  natural  to  enter  the 
receipts  of  cash  on  the  left  side  of  the  book 
and  the  payments  on  the  right.  The  next, 
and  most  inevitable  step  is  to  copy  from  this 
book  into  the  ledger  those  payments  and 
receipts  which  affect  accounts  already  in  the 
ledger — a  further  extension  of  the  principle 
of  posting  from  a  book  of  original  entry. 

This  record  of  cash  from  day  to  day  be- 
comes very  interesting,  because,  aside  from 
the  meaning  of  each  individual  entry,  the 
mere  increase  or  decrease  in  total  volume  of 
cash  transactions  begins  to  take  a  prominent 
place  as  a  rough  index  of  conditions,  and 


10    Accounting  for  the  Business  Man 

the  daily  balance  is  a  feature  of  especial 
interest  in  view  of  the  further  extension  of 
credit  transactions,  because  of  the  fact  that 
sudden  and  unexpected  demands  are  more 
frequent. 

Furthermore  the  situation  has  taken  on 
new  complications.  It  was  always  desirable 
to  know,  at  least  once  in  a  while,  whether  the 
business  had  added  anything  to  its  posses- 
sions, or  the  contrary.  Formerly,  as  we  have 
seen,  this  was  an  easier  question  to  deter- 
mine, nor  was  the  absolute  accuracy  of  the 
answer  vitally  essential.  Now,  with  the  ever- 
increasing  difficulties  in  the  way  of  an  exact 
and  timely  solution  of  the  problem,  has 
come  a  pressing  and  necessitous  cause  for 
exactitude.  It  is  the  new  partner,  who  has 
been  promised  a  certain  per  centum  of  the 
net  profit.    The  net  profit  must  be  known. 

Probably  many  weary  hours  of  fruitless 
thinking  passed  before  it  occurred  to  the 
senior  partner  that,  if  he  could  get  every- 
thing into  the  ledger  that  represented  things 
owned  or  owed,  with  the  exception  of  goods 
on  the  shelves  (which  could  be  counted  and 
valued)  he  could  get  the  answer.    The  next 


Origin  and  Foundation  Ideas        11 

step  was  to  open  a  cash  account  in  the 
ledger  into  which  he  copied  or  posted,  on  the 
proper  side  of  the  page  in  each  case,  the 
amounts  of  cash  received  and  paid  out  each 
day.  Then  from  the  first  book,  or  daybook, 
he  copied  into  the  ledger  even  the  smallest 
account  receivable  or  payable.  Then  he 
made  a  list  of  all  of  the  accounts  in  the 
ledger,  counted  up  or  inventoried  the  mer- 
chandise, and  added  together  the  values  of 
everything  the  business  owned,  including 
those  portions  of  other  people's  credit  or 
good  name  which  had  been  pledged  to  it, 
and  from  this  total  he  subtracted  those  ac- 
counts which  represented  that  portion  of  the 
concern's  credit  which  had  been  hypothe- 
cated for  goods  purchased.  The  balance 
thus  arrived  at  showed  the  net  value  in  the 
business.  By  making  a  memorandum  of 
this  net  value  somewhere  where  it  would  not 
be  lost  during  the  year,  and  then  comparing 
it  with  a  similar  balance  at  the  end  of  the 
year  the  net  improvement  or  impairment 
was  unmistakably  shown.  We  shall  see  how 
the  modem  balance  sheet  exactly  parallels 
this  simple  process. 


12    Accounting  for  the  Business  Man 

We  have  now  evolved  from  a  scratch 
book  a  complete  single-entry  system  of  ac- 
counting, and  within  the  lifetime  of  the  pres- 
ent generation  in  this  country  this  system 
was  in  common  use.  Even  to-day  one  occa- 
sionally hears  of  single-entry  bookkeeping. 
The  reform,  like  all  substantial  reforms, 
came  through  the  very  heinousness  of  the 
evils  which  called  for  reformation.  It  is, 
with  the  best  of  intentions,  very  easy  to 
make  mistakes  in  making  entries,  whether 
in  the  first  book  at  the  time  the  transaction 
occurs,  or  later  in  the  second  book  or  ledger, 
when  copying  or  posting  by  the  weak  flame 
of  a  tallow  dip,  after  the  closing  of  the  store 
for  the  night,  as  used  to  be  the  custom. 
But  with  the  introduction  of  sin  and  part- 
nership, occasional  instances  arose  where 
good  intentions  were  not  to  be  depended 
upon.  Perhaps  the  senior  partner  kept  the 
books,  and,  in  order  to  remove  the  tempta- 
tion to  extravagant  living  from  the  path  of 
the  younger  man,  minimised  the  showing  by 
increasing  the  apparent  volume  of  payables, 
or  decreasing  the  receivables.  In  many 
ways  such  a  system  was  very  susceptible  of 


Origin  and  Foundation  Ideas        13 

manipulation,  and  its  inaccuracies  very  diffi- 
cult to  detect.  Contemporaneously  with 
the  discovery  of  these  facts  there  arose  a 
desire  for  further  hght  upon  the  operations 
of  the  business.  Perhaps  a  contract  was 
made  for  the  purchase  or  sale  of  certain 
goods,  providing  for  a  rebate  if  transactions 
should  reach  a  certain  limit  within  a  given 
period.  The  accumulated  task  of  going 
through  the  first  book  to  find  all  these  items 
suggested  the  desirabihty  of  setting  aside  a 
page  in  the  second  book  or  ledger  on  which 
to  copy  every  night  the  sales  for  the  day, 
of  that  particular  article. 

From  this  proceeding  it  soon  became  ap- 
parent that  part  of  the  entries  were  going 
into  the  ledger  in  two  places — first  on  the 
debit  side  of  a  customer's  credit  record  ac- 
count, and  second  on  the  right  side  or 
credit  side  of  a  special  sales  record  account. 
At  the  same  time  there  arose  a  desire  for 
more  information  in  condensed  form  re- 
garding amounts  of  cash  or  credit  which 
were  being  expended  for  the  operating  ex- 
pense of  running  the  business.  Each  con- 
sideration,  from  its   own  standpoint,  was 


14    Accounting  for  the  Business  Man 

urging  on  to  the  inevitable  solution,  namely, 
post  or  copy  into  the  second  book  each 
transaction  on  the  debit  side  of  one  account 
and  then  on  the  credit  side  of  another. 

This  necessitates  greater  accuracy  be- 
cause it  is  at  once  obvious  that  if  each  trans- 
action appear  on  opposite  sides  of  two 
accounts,  the  total  of  all  the  debit  entries 
for  a  period  will  equal  the  total  of  all  the 
credit  entries — likewise,  taking  each  page 
or  account  by  itself,  arriving  at  the  amount 
by  which  the  left  exceeds  the  right,  or  vice 
versa,  and  then  hsting  all  of  these  balances 
on  a  sheet  of  paper,  these  balances  will  bal- 
ance each  other,  in  total.  This  is  a  trial 
balance  and  is  made  merely,  in  the  first  in- 
stance, to  determine  whether  or  not  the 
posting  has  been  correctly  done.  This  is 
double-entry  bookkeeping  and  it  has  many 
advantages  over  single  entry  aside  from 
those  already  mentioned,  and  aside  from 
the  fact  that  the  results  of  modern  ac- 
counting would  be  impossible  in  any  other 
way. 

Up  to  this  point  it  was  almost  unavoid- 
able that  the  owner  should  keep  his  own 


Origin  and  Foundation  Ideas        15 

records.  At  every  turn  his  judgment  was 
necessary  to  determine  what  should  be 
posted  into  the  ledger  and  how  it  should 
be  done.  This  condition,  probably  more 
than  anything  else,  accounts  for  the  pro- 
verbial omniscience  of  the  old-fashioned 
business  man,  and  at  the  same  time,  the 
exactions  of  so  much  confinement  to  detail 
explain  in  large  measure  his  absence  of 
leisure  to  think  out  plans  for  extending  his 
business,  creating  new  business,  and  absorb- 
ing the  business  of  his  less  astute  neigh- 
bours. 

The  development  of  higher  accounting, 
together  with  the  safeguards  thrown  around 
it,  has  enabled  the  head  to  place  the  burden 
of  this  detail  upon  other  shoulders.  This 
has  followed  closely  the  concentration  and 
organisation  which  have  occurred  in  recent 
years,  and  may,  perhaps,  be  one  of  the  large 
factors  in  that  development.  On  the  other 
hand,  it  has  led  to  a  condition  which  the  old- 
fashioned  business  man  would  have  decried, 
namely,  the  elevation  to  positions  of  im- 
portance of  many  men  who  have  no  exact 
knowledge  of  those  scientific  or  mathemati- 


16     Accounting  for  the  Business  Man 

cal  business  principles  and  methods  which 
are,  and  always  will  be,  as  inseparable 
from  a  knowledge  of  accounting  science  as 
are  the  principles  of  higher  mathematics 
from  those  of  algebra  or  geometry. 


CHAPTER  II 

THE   TRANSITION   TO   MODEEN   METHODS 

PROBABLY  the  first  attempt  to  make 
a  balancing  list  of  account  balances,  or 
trial  balance  from  the  now  complete  double- 
entry  ledger,  discovered  some  errors  in  the 
work  of  the  period.  If  the  period  was  a 
long  one  and  the  accounts  and  transactions 
considerable  in  number,  the  task  of  finding 
and  correcting  these  errors  was  a  heavy 
one.  This  experience  led  to  the  custom  of 
monthly  trial  balances  purely  for  the  pur- 
pose of  checking  up  the  correctness  of  the 
posting  more  frequently.  These  monthly 
trial  balances,  however,  soon  became  in- 
struments of  enlightenment  to  the  thought- 
ful manager,  in  many  ways,  some  of  which 
we  shall  consider  in  the  proper  place.  At 
present  our  concern  is  with  the  mechanical 
side. 
Most  of  these  errors — and  one  cent  in  a 

17 


18    Accounting  for  the  Business  Man 

single  case  will  throw  a  double-entry  ledger 
out  of  balance — arose  in  the  copying  from 
the  book  of  original  entry  into  the  ledger. 
For  example,  a  charge  to  a  customer  for 
the  sale  of  goods  was  entered  correctly  on 
the  debit  side  of  his  account,  but  was  not 
entered  on  the  credit  side  of  the  balancing 
account,  which  we  will  call  merchandise  sales 
account.  Or  it  may  have  been  entered  in- 
correctly, or  even  on  the  wrong  side.  This 
error  was  found  not  to  be  altogether  inex- 
cusable, perhaps,  because  of  the  great  pres- 
sure of  work  on  the  man  who  had  charge 
of  the  posting.  Furthermore  the  entry  in 
the  daybook  may  have  been  made  hastily, 
during  rush  of  business.  At  any  rate,  what- 
ever the  cause,  the  idea  occurred  to  some  one 
of  using  an  intermediate  book  into  which 
each  entry  should  be  carefully  copied,  in 
correct  form  for  posting  to  the  ledger,  thus 
obviating  the  necessity  of  analysing  each 
transaction  simultaneously  with  carrying  its 
two  sides  to  the  two  or  more  ledger  accounts 
concerned. 

It  frequently  requires  careful  thought  to 
decide,  even  when  one  knows,  as  from  the 


The  Transition  to  Modern  Methods      19 

daybook's  story,  just  what  the  transaction 
was,  what  accounts  are  to  be  debited  and 
credited  respectively.  Particularly  is  this 
the  case  in  complicated  entries,  as  where  a 
customer  pays  the  amount  of  his  account 
less  an  allowance  for  breakage  or  for  dis- 
count for  unexpected  promptness.  It  was 
found  that  the  mental  strain  of  deciding 
such  matters,  and  of  carrying  the  form  of 
the  entry  mentally  until  it  should  have  been 
correctly  posted,  was  too  great  for  the  aver- 
age mind  to  sustain  without  making  mis- 
takes. 

This  intermediate  book  was  called  a  jour- 
nal, for  want  of  a  better  name,  and  its 
uses  were  various.  In  some  instances  it  was 
the  channel  through  which  every  transac- 
tion passed,  in  order  to  become  properly 
formulated  for  copying  into  the  ledger.  In 
other  cases  the  cash  was  never  entered  in 
the  journal,  while  in  other  cases  it  became 
the  book  of  original  entry  for  everything, 
or  for  everything  but  cash.  In  this  case 
the  clerks  were  either  expected  to  be  able 
to  journalise  their  transactions  properly, 
or  had  to  report  them  to  an  office  man  who 


20    Accounting  for  the  Business  Man 

made  the  actual  entry.  The  daybook,  of 
course,  disappeared,  or  rather  was  merged 
with  the  journal.  The  usual  form  of  entry 
was 

John  Jones,  Dr $7.50 

To  Mdse.,  Cr 7.50 

Obviously  it  was  easier  to  copy  this  cor- 
rectly into  the  proper  ledger  accounts  than 
to  make  the  correct  posting  from  a  rough 
memorandum  to  the  effect  that  John  Jones 
bought  several  small  items,  all  of  which  are 
written  out  in  detail,  but  in  no  particular 
form. 

The  very  ease  with  which  the  work  of 
posting  could  now  be  done,  and  the  cer- 
tainty of  detection  of  errors,  led  to  a  blessed 
release  from  night  work  and  much  detail, 
for  the  more  responsible  members  of  the 
establishment.  Several  daybooks  could  be 
used  for  making  the  first  record.  Some  of 
these  could  be  in  use  in  the  store  while 
others  were  used  by  the  bookkeepers  in  the 
work  of  writing  up  the  journal. 

But  even  this  process  was  soon  found 
to  be  unduly  laborious.  It  involved  three 
entries  of  each  transa^ition,  one  in  the  day- 


The  Transition  to  Modern  Methods     21 

book,  a  second  in  the  journal,  and  a  third 
in  the  ledger.  It  also  involved  an  entry  for 
nearly  every  transaction  to  certain  few  ac- 
counts, as  merchandise  sales  and  purchases. 
A  plan  was  devised  to  dispense  with  a  large 
portion  of  this  unnecessary  work,  and  this 
was  the  step  that  led  to  many  of  the  high- 
est developments  of  the  art  of  bookkeeping, 
and  made  possible  much  of  the  progress  that 
has  been  made  in  the  science  of  accounting. 

From  the  standpoint  of  its  effect  upon 
the  mechanical  work  to  be  done,  we  speak 
of  it  as  affecting  bookkeeping  art.  For 
example,  it  was  the  beginning  of  arrange- 
ment of  books  of  original  entry  in  such 
form  that  those  accounts  requiring  most 
frequent  postings  need  be  posted  but  once 
for  a  period,  in  some  cases  a  day,  in  others 
a  week  or  a  month,  or  even  a  year.  It  is 
from  the  standpoint  of  the  effect  upon  the 
character  of  the  result  obtainable,  and  upon 
the  vital  principles  governing  the  art,  that 
we  speak  of  the  effect  upon  the  science  of 
accounting. 

The  step  in  question  was  the  invention  of 
a  journal  which  had  several  debit  and  several 


22    Accounting  for  the  Business  Man 

credit  columns,  instead  of  one  only  of  each. 
Formerly  each  entry  required  two  postings. 
In  the  new  book  one  of  the  credit  columns 
was  used  as  formerly  for  sundry  matters, 
but  where  an  entry  included  a  credit  to 
merchandise  sales,  for  example,  the  credit 
side  of  that  entry  was  not  placed  in  the 
sundry  column,  but  was  carried  into  one  of 
the  especial  credit  columns  which  was 
headed  merchandise  sales.  Cash  also  had 
its  column,  and  any  other  accounts  which 
appeared  with  great  frequency,  either  on 
the  debit  side  or  on  the  credit  side.  At  the 
end  of  the  period  the  footing  of  this  column 
was  carried  to  the  appropriate  account  in 
the  ledger,  thus  making  one  posting  where 
formerly  many  were  required.  The  work 
saved  was  more  than  appears  at  first  glance, 
but  this  was  not  the  main  result,  even  from 
the  mechanical  side.  This  classification  of 
entries  in  a  many-column  journal  suggested 
the  idea  of  devising  several  different  books 
to  take  the  place  of  one,  partly  so  that  the 
classification  might  conveniently  be  carried 
farther,  partly  for  convenience  in  a  grow- 
ing business,  of  a  clerk  for  each  different 


"  The  Transition  to  Modem  Methods     23 

branch  of  accounting  work,  and  partly  so 
that  the  work  of  posting  might  be  facil- 
itated. This  occurred  through  the  farther 
classification  and  also  because  of  the  fact 
that  there  were  now  several  books  from 
which  to  post  the  ledger  instead  of  one,  and 
hence  it  became  easier  to  get  possession  of 
one  of  them  for  that  purpose. 

The  various  books  of  original  entry  now 
in  use  are  somewhat  confusing  to  the  be- 
ginner, but  it  is  only  necessary  to  bear  in 
mind  the  fact  that  each  one  of  them  must  be 
some  portion  of  the  old  many-column  jour- 
nal, so  arranged  as  to  be  adaptable  to  a 
special  purpose.  There  is  only  one  way  in 
which  an  entry  can  get  into  the  ledger  with- 
out making  trouble,  and  that  is  in  conform- 
ity with  the  time-honoured  two  rules  of 
bookkeeping,  namely,  "  There  must  be  a 
debit  for  every  credit "  and  "  Debit  what 
comes  in  or  costs  something;  credit  what 
goes  out  or  produces  something."  Every 
book  of  original  entry  must  provide  for 
operations  in  strict  conformity  with  these 
two  rules.  The  difference  is  merely  one  of 
form,  with  the  purpose  of  securing  greater 


24    Accounting  for  the  Business  Man 

results  with  less  work.  One  reason  why 
other  books  were  devised,  was  that  the 
many-column  journal  continued  to  grow  in 
size  and  number  of  columns  until  it  became 
a  very  unwieldy  book  and  still  it  failed  to 
keep  pace  with  the  development  of  a  modern 
ledger  system,  in  which  one  central  ledger 
was  to  act  as  key  to  all  the  rest  through  the 
establishment  of  governing  accounts.  That 
is  a  subject,  however,  which  will  be  taken 
up  at  another  time.  It  is  merely  mentioned 
here  in  passing  as  having  been  one  of  the 
influences  leading  to  the  greater  elabora- 
tion of  the  books  of  original  entry. 

These  naturally  divide  themselves  ac- 
cording to  the  character  of  the  transactions 
of  the  business  in  question.  And  it  must 
not  be  imagined  that  two  establishments 
putting  out  identical  products,  can  use 
identical  books  and  systems.  Every  feature 
of  organisation,  the  character  of  the  prin- 
cipal employees,  relations  with  customers, 
and  many  other  things  have  a  bearing  upon 
the  matter.  The  main  thing,  however, 
which  must  be  borne  in  mind  is  the  character 
of  information  to  be  derived  from  the  com- 


The  Transition  to  Modern  Methods     25 

pleted  record,  but  an  understanding  of  the 
ideal  ledger  system  is  essential  to  a  full  com- 
prehension of  this  point,  and  we  shall  con- 
fine our  present  discussion  to  the  more 
mechanical  matter  of  convenient  arrange- 
ment of  original  entries  for  posting  to  one 
all-embracing  ledger. 

Usually  there  are  six  divisions  into  which 
these  naturally  fall. 

First  of  all  it  is  necessary  to  purchase 
something,  whether  raw  material  for  manu- 
facture, or  finished  goods  at  wholesale,  for 
resale  at  retail.  Perhaps  the  next  purchase 
will  be  supplies  of  some  character  for  use 
in  operating,  and  still  another  may  be  some 
article  of  fixed  investment,  as  a  machine, 
horse  and  wagon,  or  additional  bit  of  land 
for  storage  or  extension.  These  are  all  pur- 
chases on  credit.  The  one  imperative  con- 
sideration is  that  they  should  be  credited  to 
the  person  from  whom  they  were  purchased, 
so  that  when  the  day  of  settlement  comes, 
his  ledger  account  shall  slaow  accurately  tte 
amount  due  him.  It  is  vitally  essential  at 
this  point,  however,  to  keep  the  mind  free 
from  confusion  regarding  these  two  trans- 


26    Accounting  for  the  Business  Man 

actions,  namely  the  purchase  to-day  and  the 
payment  at  some  future  date.  From  the 
standpoint  of  bookkeeping  they  have  noth- 
ing to  do  with  each  other.  We  buy  the 
goods,  and  the  transaction  is  complete  when 
we  pay  out  our  credit  by  making  a  note  to 
that  effect  on  the  credit  side  of  our  friend's 
account  on  our  ledger.  This  entry  is  form- 
alised and  prepared  for  posting  in  a  book 
which  we  might  call  a  purchase  record,  re- 
membering always  that  it,  like  the  other 
books  of  original  entry,  is  merely  a  portion 
of  the  old  intermediate  journal  so  arranged 
that  it  shall  be  especially  suitable  to  the 
purpose.  We  have  abandoned  the  daybook, 
and  the  entry  is  made  in  the  purchase 
record  usually  from  a  bill  either  sent  with 
the  goods,  or  mailed  separately.  This  bill 
should  pass  through  the  hands  of  the  re- 
ceiving clerk  (or  be  compared  with  his 
receiving  records)  and  show  by  a  notation 
that  the  goods  have  come  in  in  good  condi- 
tion; it  should  then  be  audited  as  to  prices 
charged  and  correctness  of  extensions  and 
footings;  then  the  question  of  deductions 
and  allowances  should  be  considered,  and 


The  Transition  to  Modern  Methods      27 

finally,  some  one  in  authority,  and  fully  con- 
versant with  the  whole  system  and  object  of 
the  accounting  organisation,  should  indicate 
the  account  to  which  the  charge  or  charges 
shall  be  made.  This  is  a  matter  worthy  of 
the  closest  and  most  competent  scrutiny. 
For  example,  the  dividing  line  between 
materials  and  supphes  is  very  hard  to  dis- 
tinguish on  certain  items ;  again,  those  items 
which  are  unquestionably  supplies  may  come 
in  in  quantities  so  great  that,  instead  of 
charging  directly  to  expense  account,  they 
should  be  carried  in  supply  inventory  ac- 
counts and  charged  out  by  periodical  en- 
tries. (This  matter  will  be  more  fully  dis- 
cussed in  the  chapter  on  reserves,  etc.) 
Another  instance  where  both  care  and  ex- 
tensive knowledge  are  requisite  is  in  charg- 
ing purchases  of  things  which  look  Hke  new 
investment.  This  is  dangerous  ground. 
An  entirely  new  machine,  for  example, 
may  be  rendered  necessary  by  advancement 
in  the  state  of  the  art,  old  machines  and 
methods  becoming  obsolete  and  unprofitable. 
Unless  the  old  investment  is  "  charged  off  " 
the  new  must  not  be  added  to  an  account 


28    Accounting  for  the  Business  Man 

which  will  make  it  appear  to  be  an  increase 
of  valuable  things  owned  by  the  business 
(i.e.,  assets).  (This  matter  also  will  be  dis- 
cussed at  greater  length  in  the  chapter  on 
reserves,  etc.) 

The  charge,  or  debit  side  of  the  entry  hav- 
ing been  determined  and  indicated  on  the 
bill,  we  are  ready  to  consider  the  form  in 
which  it  will  appear  on  the  purchase  record. 
(There  is  no  beginning  so  good,  in  reform- 
ing the  accounting  system  of  a  concern, 
after  determining  the  ultimate  results  de- 
sired, as  a  careful  study  of  a  large  number 
of  purchase  bills.)  It  will  be  found  that 
the  face,  or  total  amount  of  the  bill,  after 
the  deduction  of  trade  discounts,  is  not  al- 
ways to  be  credited,  without  reservation, 
to  the  "  purchase  account,"  i.e.,  the  person 
or  concern.  There  are  various  causes  for 
deductions,  which  do  not  and  should  not 
affect  the  amount  to  be  charged  to  the 
proper  account.  For  example,  the  market 
value  of  certain  goods  is  fixed  at  a  certain 
price ;  every  one  else  pays  that  price,  and  we 
may  be  obhged  to  do  so  again  shortly;  fur- 
thermore, that  fixed  price  is  the  price  at 


The  Transition  to  Modern  Methods     29 

which  costs  must  be  figured.  Nevertheless, 
by  especial  agreement,  we  are  allowed  to 
deduct  a  certain  percentage  from  the  face 
of  the  bills;  by  a  similar  arrangement,  we 
may  secure  the  concession  of  a  freight  allow- 
ance which  is  to  be  deducted  from  the  face 
of  the  bill  when  it  is  credited,  but  which 
ought  to  be  included  in  the  cost  of  goods 
and  therefore  in  the  charge  to  inventory  or 
expense  account.  These  deductions  take  the 
form  of  an  especial  revenue.  These  facts 
necessitate  one  or  more  columns  on  the 
credit  side  of  the  purchase  record,  in  addi- 
tion to  the  column  in  which  the  amount  of 
credit  to  the  personal  account  is  to  appear, 
both  for  the  purpose  of  getting  the  whole 
entry  on  one  line  horizontally  and  also  to 
save  posting.  These  extra  columns,  if 
named  according  to  accounts  in  the  ledger, 
can  obviously  be  posted  in  total  from  foot- 
ings at  the  end  of  a  period.  The  left,  or 
debit  side  of  this  book  calls  for  much  more 
careful  thought.  The  principal  entries  on 
that  side  will  be  those  covering  charges  to 
the  account  or  accounts  which  may  be 
used  to  show  the  volume  of  merchantable 


80    Accounting  for  the  Business  Man 

material  purchased,  whether  it  be  raw  stuflp 
for  manufacture,  or  finished  goods  for  re- 
sale, or  some  other  form  of  goods  or  chat- 
tels, the  object  of  operation  and  the  source 
of  profit  thereon.  This  set  of  charges  may 
go  into  one  column  called  merchandise,  or 
purchases  of  material  (or  some  other  appro- 
priate name).  It  may  be  distributed 
through  several  columns  arranged  accord- 
ing to  some  classification,  as  of  the  goods 
according  to  their  nature,  the  margins  of 
profit  thereon,  the  departments  of  the  busi- 
ness to  which  they  belong,  or  some  other 
consideration.  In  addition  to  this  main 
group,  a  sundries  column  for  unusual 
charges,  like  purchases  of  machinery,  should 
be  provided.  (This  column  can,  of  course, 
not  be  posted  in  total.)  There  must  also 
be  one  or  more  columns  for  entering  charges 
to  expense,  of  supplies,  and  of  bills  for  con- 
sumption of  gas,  water,  etc.  If  one  or  very 
many  expense  accounts  be  maintained,  it 
is  usually  best  to  confine  all  such  items  to 
one  column  (an  exception  may  be  made  in 
the  case  of  one  or  two  accounts  to  which  a 
large  number  of  charges  must  be  made). 


The  Transition  to  Modern  Methods      31 

Where  all  expense  items  are  confined  to  a 
small  nmnber  of  accounts,  a  colmnn  may- 
be provided  for  each.  In  general,  it  is  well 
to  avoid  increasing  the  number  of  columns. 
It  is  better  to  recapitulate  than  to  use  very 
bulky  books  of  original  entry,  in  most  cases. 

It  is  undesirable,  at  this  point  to  go  too 
far  into  detail  regarding  the  forms  of 
these  books,  because  there  is  a  broader  con- 
sideration in  their  make-up  than  any  yet 
described  and  one  whose  influence  is  para- 
mount to  everything  else.  It  is  the  char- 
acter and  organisation  of  the  ledger  system, 
and  will  be  discussed  in  the  next  chapter. 

The  other  five  sources  of  original  entry 
are,  in  the  order  in  which  it  is  often  found 
desirable  to  take  up  their  consideration,  the 
record  of  cash  paid  out,  the  record  of  sales, 
the  record  of  cash  received,  the  record  of 
petty  cash  disbursements,  and  the  record 
of  all  entries  which  do  not  readily  fall  into 
any  one  of  these  classes,  such  as  adjustments 
between  two  accounts  already  on  the  books, 
entries  of  bills  or  notes  received  from  cus- 
tomers in  lieu  of  their  open  accounts  on  the 
ledger,  et  cetera. 


32    Accounting  for  the  Business  Man 

There  is  another  source  of  entry  which 
has  not  been  here  considered  because  it  be- 
longs, to  a  greater  extent,  to  the  realm  of 
department  and  detail  cost  accounting,  and 
will  be  discussed  under  that  head.  It  need 
not  to  be  taken  up  here  because,  unless  we 
go  into  the  cost  question,  sufficiently  illumi- 
nating entries  on  the  debit  side  can  be 
made  in  the  record  of  cash  paid  out  at  the 
time  the  pay-roll  checks  were  drawn. 

Reasoning  similar  to  that  used  in  describ- 
ing the  purchase  record  will  make  the  other 
books  clear  to  the  mind.  The  book  was 
here  described  merely  to  illustrate  the  hne 
of  thought  followed  in  breaking  up  the  old 
intermediate  journal  into  various  other  and 
more  convenient  records,  and  to  suggest  to 
the  reader's  mind  an  example  of  the  influ- 
ence which  that  disintegration  has  had  upon 
the  mechanical  side  of  the  subject — the  side 
which  may  reasonably  be  called  the  art  of 
bookkeeping,  as  distinguished  from  the  sci- 
ence of  accounting. 

The  effect  upon  the  science  comes  through 
the  fact  that  this  process  of  development 
has  made  it  possible  to  obtain  results  which, 


The  Transition  to  Modern  Methods     33 

both  in  their  timeliness  and  in  their  intrinsic 
character  and  value,  are  greater  and  more 
potent  for  good  (or  evil)  than  any  results 
which  could  have  been  obtained  without 
these  changes. 

These  results  are  made  possible  by  the 
elaboration  of  the  ledger  system,  which,  in 
turn,  would  have  been  a  practical  impos- 
sibihty  had  we  continued  to  post  the  ledger 
directly  from  the  daybook.  Even  the  many- 
column  journal  would  have  been  an  ex- 
ceedingly sluggish  channel  for  the  even  flow 
of  material,  in  the  form  required  to  spread 
it  on  the  face  of  a  well-laid-out  ledger  sys- 
tem. The  next  chapter  will  take  up  that 
subject. 


CHAPTER  III 

THE   REORGANISED   LEDGER   SYSTEM 

THE  "  second  book  "  or  ledger,  which 
came  into  existence  merely  as  a  con- 
venient place  to  record,  on  separate  pages, 
the  items  of  the  longer  and  more  active 
accounts,  and  later  on  absorbed  all  credit 
accounts,  both  for  and  against,  became  a 
very  burdensome  and  unwieldy  machine 
with  the  increase  of  business  volume  and 
complexity,  which  led  to  double-entry  book- 
keeping. Ledgers  of  this  period  were  im- 
mense in  bulk,  and  the  work  of  posting  all 
transactions  from  the  various  books  of 
original  entry  to  one  great  ledger  came  to 
be  more  than  one  man  could  do. 

Here  let  it  be  understood  that  the  pur- 
pose is  not  so  much  to  be  historically  and 
chronologically  accurate,  as  to  present  in  a 
graphic  manner  the  conditions  and  causes 
which  led  to  certain  developments,  with  the 

84 


The  Reorganised  Ledger  System     85 

view  of  making  those  developments  and  the 
reasons    therefor   more    easily    understood. 

To  obviate  this  purely  mechanical  diffi- 
culty, the  ledger  accounts  were  divided 
among  two  or  more  books  of  the  same 
form,  the  accounts  were  arranged  alpha- 
betically, and  the  operation  was  exactly  as 
before.  It  was  necessary  for  each  ledger 
clerk  to  go  through  all  books  of  original' 
entry,  selecting  those  accounts  which  be- 
longed to  his  book.  Another  plan  of  di- 
vision was  to  include  all  sales  accounts  in 
one  ledger,  and  all  purchase  accounts  in 
another.  This  was  the  first  step  toward  the 
modern  classification  of  the  ledgers  accord- 
ing to  the  character  of  material  belonging 
to  each  and  marked  the  second  great  step 
toward  a  more  scientific  understanding  of 
the  whole  subject. 

One  great  disadvantage  of  having  all 
accounts  in  one  or  two  ledgers  was  the 
amount  of  information  which  was  open  to 
the  office  force  generally.  In  fact,  the  only 
thing  lacking  to  enable  any  bookkeeper  to 
know  the  exact  condition  of  the  business 
was  the  value  of  inventories  when  taken. 


36    Accounting  for  the  Business  Man 

It  was  necessary  in  "  closing  the  books  "  to 
enter  these  inventories  (this  will  be  ex- 
plained in  the  next  chapter),  hence  there 
could  be  little  secrecy  about  the  most  vital 
affairs  of  the  business. 

This  consideration  led  to  carrying  the 
principle  of  segregation  farther,  and  the 
so-called  general  ledger  came  into  existence. 
In  this  ledger  were  carried  all  those  ac- 
counts which  were  neither  sales  nor  pur- 
chase accounts,  and  even  some  of  these 
accounts  were  included  in  this  ledger,  which, 
for  obvious  reasons,  was  also  spoken  of  as 
the  private  ledger.  This  arrangement  made 
possible  a  distribution  of  work  among  any 
requisite  number  of  clerks  and  left  the 
private  affairs  of  the  business  largely  in  the 
hands  of  a  confidential  man,  but  it  was  a 
transitional  stage,  and,  as  such,  had  serious 
disadvantages.  For  example,  a  trial  bal- 
ance involved  the  absolute  accuracy  of  all 
the  work  on  all  the  ledgers,  and  condensed 
statements  could  not  readily  be  made. 
Everything  was  in  readiness,  however,  for 
the  next  and  final  stage  of  development. 
It  became   evident   that  if  the   books   of 


The  Reorganised  Ledger  System     37 

original  entry  could  be  so  arranged  that 
total  figures,  for  the  period,  of  all  postings 
to  any  certain  ledger  or  group  of  ledgers, 
could  be  easily  incorporated  in  a  govern- 
ing account  in  the  general,  or  private 
ledger,  the  problem  would  be  solved.  This 
ledger  would  not  only  become  independent 
of  the  others  and  self-balancing,  but  it 
would  contain  within  its  own  pages  a 
gauge  by  which  to  determine  the  accuracy 
of  the  work  on  the  others.  At  the  same 
time  the  values  of  things  owned  or  owed, 
as  shown  by  the  other  ledgers,  or  any  other 
information  entrusted  to  them  would  appear 
in  condensed  form  in  a  statement  of  the 
balances  of  these  governing  or  controlling 
accounts. 

Two  means  of  accomplishing  the  pur- 
pose presented  themselves.  One  was  by  re- 
capitulation of  the  books  of  original  entry, 
and  the  other  was  by  rearrangement  of  these 
books  in  such  way  as  to  provide  columns 
whose  totals  could  be  carried  to  these  con- 
trolling accounts.  The  latter  course,  at 
first  glance,  appeared  to  present  the  objec- 
tion of  greatly  multiplying  the  number  of 


88    Accounting  for  the  Business  Man 

columns  necessary  to  be  introduced  in  each 
of  these  books.  More  careful  examination 
removed  much  of  this  apprehension,  and 
disclosed  the  fact  that  in  some  instances  the 
columns  already  in  use  were  adequate  to 
the  purpose,  by  supplementing  their  work 
with  a  small  amount  of  recapitulation,  while 
in  other  cases  the  addition  of  one  or  two 
columns  was  sufficient. 

For  example,  the  purchase  record  already 
briefly  described  was  furnished  with  two. 
columns  only  on  the  right,  or  credit  side. 
One  of  these  columns  provides  for  credits 
to  the  personal  accounts  in  the  purchase 
ledger,  while  the  other  is  for  deductions 
or  allowances.  Obviously  the  total  of  the 
first  is  complete  in  itself  as  representing  the 
aggregate  amount  to  be  credited  to  that 
subsidiary  ledger  which  has  been  entrusted 
with  the  record  of  extension  of  our  good 
name  or  credit  in  exchange  for  goods  or 
other  values.  The  second  column  contains 
items  which  we  have  already  spoken  of  as 
especial  revenue,  in  character.  In  so  far  as 
we  have  gone,  such  accounts  are  still  carried 
in  the  private  or  general  ledger,  hence  this 


The  Reorganised  Ledger  System     39 

column,  in  one  item,  or  split  up  and  re- 
capitulated, according  to  the  custom,  would 
go  directly  into  one  or  more  accounts  in 
that  ledger. 

The  debit  side  begins  with  columns  for 
the  value  of  goods  purchased.  These  might 
be  called  merchandise  inventory  columns. 
The  corresponding  accounts  would  be  car- 
ried in  the  general  ledger  (unless  an  in- 
ventory ledger  be  maintained,  an  explana- 
tion of  which  will  appear  later)  and  again 
there  would  be  no  question  of  a  controlling 
account,  for  the  very  good  reason  that  these 
items  are  posted  to  no  other  ledger.  The 
sundries  column  contains  items  mostly 
chargable  to  general  ledger  accounts,  though 
an  occasional  charge  to  a  personal  ledger 
may  appear,  in  which  case  it  is  to  be  posted 
in  detail  (recapitulated  if  there  be  several) 
to  the  appropriate  governing  account.  Of 
the  expense  account  columns  the  same  is 
true  as  of  the  inventory  columns,  unless  an 
expense  and  revenue  ledger  be  operated 
(explanation  later)  in  which  event,  natu- 
rally, the  totals  would  go  to  expense  and 
revenue  governing  account. 


40    Accounting  for  the  Business  Man 

We  might,  with  no  great  variation  of 
result,  go  through  the  other  five  sources  of 
original  entries,  but  the  above  is  sufficient 
to  illustrate  the  principle  and  it  seems  bet- 
ter to  avoid  going  too  much  into  detail 
regarding  forms,  whether  of  original  entry- 
books,  or  ledgers,  until  the  underlying 
principles  shall  have  been  more  extensively 
discussed.  The  aim  is  to  build  a  founda- 
tion of  general  knowledge  of  the  bearings 
of  things  before  laying  too  much  stress 
upon  the  exact  manner  of  doing  them. 

The  vital  thing  at  this  point  is  that  the 
reader  grasp  the  idea  that  from  a  rough 
memorandum  book  of  no  particular  form, 
and  with  no  fixed  laws  of  usage,  and  telling 
nothing  complete  or  comprehensive  about 
the  business,  there  has  evolved,  by  natural 
and  inevitable  stages,  a  system  with  a 
governing  ledger  at  one  end  and  a  variety 
of  conveniently  arranged  books  of  original 
entry  at  the  other,  while  between  the  two 
comes  in  an  elastic  series  of  detail  ledgers 
into  which  various  classes  of  transactions 
or  entries  are  copied  or  posted  in  such  a 
way  as  best  to  serve  the  purpose  of  those 


The  Reorganised  Ledger  System     41 

who  are  to  be  guided  thereby  in  the  formu- 
lation of  the  policy  of  the  business. 

In  the  beginning,  the  use  of  a  diary  or 
daybook  was  forced  upon  the  business  man 
simply  because  his  memory  was  not  good 
enough  to  keep  up  with  a  growing  business. 
Next  came  the  evolution  period,  and  now 
we  have  a  scientific  system,  self -proving  and 
the  source  of  endless  enlightenment  when 
properly  utilized. 

The  key  to  the  situation  is  the  governing 
ledger,  because  it  shows  the  facts  in  con- 
centrated form.  A  balance  sheet  from  it 
gives  the  condition  of  the  business,  show- 
ing in  a  single  item  the  net  values,  for  or 
against,  which  the  subsidiary  ledgers  show 
in  detail.  It  is  with  the  coming  of  this 
phase  that  certain  basic  principles  have  es- 
tablished themselves,  in  such  manner  as  to 
warrant  the  appUcation  of  the  term  science. 
In  many  ways,  the  mental  processes  by 
which  a  well-organised  system  of  accounts 
is  to  be  created  and  enforced  in  any  busi- 
ness are  exactly  parallel  to  the  action  of 
the  mind  in  solving  "  original "  problems 
in  geometry.     We  have  the  premises  and 


42    Accounting  for  the  Business  Man 

the  conclusion.  We  have  studied  the  prin- 
ciples and  their  application  to  other  prob- 
lems. The  task  before  us  is  the  construc- 
tion of  a  network  to  connect  premises  and 
conclusion,  and  it  is  safe  to  say  that  the 
mind  that  halted  at  original  work  in  geom- 
etry would  do  well  to  avoid  the  attempt 
to  do  creative  work  in  accounting.  Every- 
thing must  be  proven,  and,  before  any 
device  is  tried,  exact  reasoning  must  be 
brought  to  bear,  in  order  to  determine 
whether  it  will  work.  Unmathematical 
minds  may  get  a  good  knowledge  of  the 
subject,  and  may  even  successfully  operate 
the  most  elaborate  system,  but  the  safer 
course  for  them  is  the  avoidance  of  creative 
work. 

Another  great  difficulty  arises  from  the 
fact  that  all  the  materials  to  work  with 
consist  of  unformulated  and  almost  in- 
tangible things.  There  is  such  an  infinite 
variety  of  conditions  to  be  taken  into  ac- 
count that  no  set  rules  of  procedure  can 
be  laid  down,  and  no  stereotyped  forms 
can,  with  safety,  be  employed.  From  the 
peculiarities  of  doing  business  which  affect 


The  Reorganised  Ledger  System     43 

the  form  of  the  original  entry,  through  to 
the  hobby  of  the  owner  as  to  the  character 
of  information  desired  from  the  balance 
sheet,  or  the  cost  records,  there  are  many 
things  miique  to  each  system,  and  to  pro- 
vide for  which  the  form  must  be  especially 
adapted.  The  result  is  that  each  new  sys- 
tem is  like  the  solution  of  a  new  problem  in 
Unes,  angles,  surfaces,  and  solids;  and  in 
addition  to  a  knowledge  of  what  has  been 
done,  and  why,  a  certain  creative  or  in- 
ventive perspicacity  is  necessary  to  success. 
This  fact  need  not  discourage  the  business 
manager  who  desires  to  understand  the 
subject,  but  feels  the  absence  of  this  faculty. 
The  percentage  of  the  class  who  learn  and 
understand  the  printed  demonstrations  is 
much  greater  than  of  those  who  find  original 
solutions. 

We  have  occupied  ourselves  with  the 
most  general  phases  of  the  subject  up  to 
the  present  time.  In  the  following  chap- 
ters we  shall  begin  to  get  nearer  to  tech- 
nicalities. We  shall  discuss  the  opening 
and  closing  of  a  set  of  accounts,  and  shall 
then  proceed  to  a  consideration  of  the  char- 


44    Accounting  for  the  Business  Maa 

acter  of  the  various  accounts  and  classes  of 
accounts.  This  will  naturally  bring  us  to 
the  question  of  the  treatment  of  these  classes 
of  accounts  in  the  ledger  system,  and  to 
their  meaning  in  and  bearing  upon  state- 
ments of  results.  The  balance  sheet  comes 
next  and  that  will  be  quite  naturally  fol- 
lowed by  a  discussion  of  valuations,  re- 
valuations, inventories,  reserves,  etc 


CHAPTER  IV 

OPENING  THE  LEDGER 

IN  the  days  of  memorandum-book  ac- 
counting, the  opening  of  a  set  of  books 
was  a  simple  matter.  Sometimes  it  was 
attended  by  certain  formalities,  as  the  in- 
scribing on  the  first  page  of  the  daybook 
the  agreement  between  the  partners,  but  it 
remained  for  experience  in  the  development 
of  the  ledger  system,  and  its  bearing  upon 
the  question  of  gain  or  loss,  to  emphasise  the 
importance  of  beginning  with  an  exact  and 
careful  statement  of  just  what  the  business 
owned  and  owed  at  the  start.  In  no  other 
way  is  it  possible  to  arrive  at  a  comparison 
with  the  condition  at  a  later  date,  for  the 
purpose  of  ascertaining  the  amount  of  gain 
or  loss  on  the  operations  of  the  period. 

The  first  step,  therefore,  is  to  make  a  list 
or  inventory  of  everything  owned  and  owed. 
This  list  should  be  carefully  and  closely 

45 


46    Accounting  for  the  Business  Man 

scrutinised  by  every  one  concerned.  The 
importance  of  this  can  not  be  overstated, 
because  it  bears  upon  every  relation,  and 
affects  the  whole  history  of  the  business. 
The  net  value  shown  by  this  list  is  natu- 
rally the  basis  of  credit  for  the  first  period, 
or  until  accurate  accounting  shall  have 
shown  an  accretion  of  further  values. 

This  hst  should  be  made  very  clear  and 
very  explicit,  so  that  any  one  interested  may 
take  it  and  check  off  the  items  and  their 
valuations  with  the  things  listed.  The  pos- 
sessions, or  assets,  consist  of  cash,  of  object 
of  operations  (as  material  or  goods),  sup- 
plies, plant,  real  estate,  securities,  facilities 
(as  water-power  or  other  natural  and  tan- 
gible means  of  producing  income  or  reduc- 
ing expense  below  the  normal),  and  those 
portions  of  the  realisable  credit  or  good 
name  of  others  which  may  belong  to  the 
business.  Contracts  which  have  cost  some- 
thing and  which  are  certain  to  produce  a 
net  value,  as  well  as  valuable  patents  and 
privileges,  may  also  be  included.  There  is 
also  a  condition  under  which  it  is  legiti- 
mate to  include  the  good  will  of  an  estab; 


Opening  the  Ledger  47 

lished  and  successful  business  in  this  state- 
ment, but  there  is  no  occasion  for  this  unless 
the  business  ownership  is  undergoing  some 
change,  as  a  transfer  to  a  partnership,  to 
new  owners,  or  to  a  capitalised  company. 
It  is  for  the  new  interest  to  insist  upon  the 
production  of  this  document,  and  to  secure 
careful  and  competent  scrutiny  of  its  show- 
ing. Investors  lose  much  money  every 
year  by  putting  it  into  enterprises  with- 
out taking  this  most  simple  and  necessary 
precaution.  To  take  such  a  step  is  the 
height  of  folly,  and  it  is  equally  unwise  to 
accept  a  list  as  presented,  without  having 
it  thoroughly  analysed.  Nor  is  it  ever 
necessary  to  do  so.  In  every  city  in  the 
country  are  to  be  found  able  men  follow- 
ing the  profession  of  business  accounting. 
To  the  average  investor  the  services  of 
such  a  man  are  even  more  important  than 
those  of  a  lawyer,  and  this  fact  will  in 
time  be  recognised.  No  investor  who  is  not 
well  versed  in  the  subject  will  put  his 
money  into  any  enterprise  without  the  re- 
port of  a  competent  expert.  We  do  not 
now  invest  in  mines  without  first  endeav- 


48    Accounting  for  the  Business  Man 

curing  to  get  the  judgment  of  a  competent 
and  trustworthy  engineer  upon  the  three 
vital  questions  of  mine,  money,  and  man- 
agement. Other  enterprises  are  just  as 
hazardous.  Unless  there  are  the  field,  the 
means,  and  the  management  in  proper  pro- 
portion and  combination,  it  is  just  as  dan- 
gerous to  invest  money  in  a  factory  as  in  a 
mine,  despite  the  fact  that  there  may  be  a 
building  which  can  be  seen,  machinery 
which  can  be  heard,  and  material  which 
can  be  inventoried.  These  things  are  at  par 
only  when  supported  by  sufficient  working 
capital  and  adequate  brains.  The  next  ad- 
vance in  business  solidification  will  come 
with  a  recognition  of  the  field  of  the  com- 
petent accountant  as  an  adviser  to  the  in- 
vestor, and  that  \^dll  be  followed  by  the 
introduction  of  these  trained  business  engi- 
neers into  boards  of  directors  as  representa- 
tives of  the  various  interests.  This  is  not 
said  so  much  of  the  generality  of  men  now 
practising  the  profession,  as  of  the  profes- 
sion itself  and  of  the  modern  tendencies  of 
business  organisation.  With  this  develop- 
Oient  will  com^  as  complete  a  recognition 


Opening  the  Ledger  49 

of  the  responsibilities  of  boards  of  directors 
as  ah-eady  exists  in  older  countries.  The 
application  of  exact  science  to  the  opera- 
tion of  a  business,  and  to  the  represen- 
tations which  it  will  make  regarding  its 
condition,  will  go  farther  than  any  other 
development  toward  bringing  us  back  to 
sound  business,  banking,  and  currenc}^  prin- 
ciples, from  which  we  have  made  so  long 
a  departure,  and  on  account  of  which  depar- 
ture we  and  our  irrational  periods  of  alter- 
nating exaltation  and  depression  are  to-day 
the  laughing-stock  of  the  civilised  world. 

One  more  generalisation  before  returning 
to  the  technicalities  of  the  "  opening.'* 
There  are  two  influences  opposing  the  de- 
velopment of  sounder  methods  and  greater 
pubUcity  and  frankness  of  statement.  Both 
are  selfish,  one  ignorantly  and  ill  advisedly, 
the  other  shrewdly  and  designedly.  The 
first  is  the  desire  of  the  small  and  weak 
to  conceal  the  truth  in  the  hope  of  being 
over-estimated.  The  other  is  the  realisa- 
tion on  the  part  of  powerful  interests 
that  this  condition  places  the  whole  com- 
munity  within   their   power.     The   banks 


50    Accounting  for  the  Business  Man 

first,  because  our  present  system  discour- 
ages the  extension  of  facilities  to  the  smaller 
enterprises;  the  public,  because  it  is  con- 
sidered safer  to  invest  in  large  enterprises 
and  because  concealment  of  true  condition 
is  the  opportunity  required  for  manipula- 
tion of  market  values  of  securities;  and 
finally  the  small  man  who,  because  of  his 
lack  of  support  from  banks  and  the  pubhc, 
is  the  more  easily  absorbed.  In  this  manner 
the  indisposition  of  the  small  man  to  show 
his  true  condition  results  in  making  him  co- 
operate with  his  greater  enemy  against  his 
own  well-being.  The  remedy  lies  in  more 
truthful  and  more  uniform  accounting, 
from  which  the  banks  may  know  the  exact 
condition  of  all  their  clients,  so  that  all 
may  be  treated  aUke.  This  is  the  great 
foundation  which  must  be  built  by  the  busi- 
ness community  before  legislation  on  the 
banking  and  currency  questions,  however 
wise,  can  become  freely  operative.  When 
the  solidity  of  commercial  paper  becomes  an 
established  and  certain  quantity,  the  banks 
and  clearing-house  organisations  will  need 
little  help  from  legislation. 


Opening  the  Ledger  51 

The  basis  of  this  reformation  lies  in  the 
manner  of  making  the  list  of  things  owned 
and  owed,  or  of  assets  and  liabiUties  with 
which  to  open  the  books,  and  its  continu- 
ance will  depend  upon  the  truthful  pres- 
entation of  these  facts  and  the  intelhgent 
operation  of  proper  accounting  methods  in 
recording  the  changes  due  to  operation  of 
the  business  during  any  period. 

Having  made  a  careful  list  of  every  valu- 
able thing  owned  by  the  business,  placing 
the  money  value  opposite  each  item,  the 
next  step  is  to  ascertain  just  as  carefully 
everything  for  which  the  business  may 
stand  liable.  This  should  include  not  only 
the  extension  of  its  credit  for  any  cause 
whatever,  but  also  accumulations  of  unpaid 
taxes,  interest,  or  other  dues,  whether  or 
not  there  be  a  visible  record.  Another 
point  which  should  have  careful  considera- 
tion is  the  liability  on  any  disadvantageous 
contract.  If  contracts  exist,  they  should 
be  carefully  analysed,  to  ascertain  whether 
there  be  an  equity  of  value  in  them,  or  a 
liability  to  loss.  In  either  case  a  valuation 
should  be  made  and  included  in  this  list. 


52    Accounting  for  the  Business  Man 

We  have  already  seen  how  it  came  about 
that  things  owned — assets — appear  on  the 
debit  or  left  side  of  the  page  in  early  ac- 
counting. This  arrangement  is  followed  in 
making  the  list,  or  balance  sheet,  for  the 
two  are  identical.  Obviously  if  the  balance 
sheet  shows  a  greater  total  on  the  left  or 
debit  side,  the  assets  aggregate  more  than 
the  liabilities,  and  there  is  an  equity  in  the 
business.  A  greater  total  on  the  right,  or 
liabiUty  side,  means  insolvency  and  there  is 
neither  need  nor  the  right  to  go  farther, 
because  this  balance  is  the  basis  upon  which 
the  world  not  only  gives  credit  to  the  busi- 
ness, but  takes  the  chance  of  entering  into 
contract  relations  in  the  hope  of  mutually 
advantageous  dealings. 

The  excess  of  assets  over  Uabilities,  the 
equity  as  shown  by  the  Ust,  is  what  belongs 
to  the  owner  or  owners  of  the  business,  and 
yet  it  does  not  morally  confer  the  rights  of 
full  ownership  so  long  as  the  business  has 
any  unpaid  liabilities.  Its  creditors,  for 
their  own  protection,  and  the  intelligent 
and  appropriate  departments  of  govern- 
ment, for  the  protection  of  the  public  from 


Opening  the  Ledger  51!^ 

the  incidental  effects  of  disaster,  have  the 
right  to  know  how  matters  stand,  and  the 
general  course  of  events.  Indeed  it  is  to 
the  advantage,  directly  or  indirectly,  of 
every  man  to  have  every  one  else  properly 
supervised,  within  reason,  in  this  as  well  as 
in  other  ways. 

This  equity  is  the  amount  that  the  busi- 
ness, as  an  imaginary  person,  owes  to  the 
men  who  are  called  its  owners.  It  is  per- 
fectly logical,  therefore,  to  credit  the 
amount  to  their  personal  account  on  this 
list,  it  being  understood,  however,  that  this 
obligation  of  the  business  stands  last  as  to 
precedence  in  every  way.  If  the  things  in- 
cluded as  assets  be  not  sound,  or  if  the  list 
of  liabihties  be  incomplete,  this  equity 
credited  to  the  owners  in  the  hst  will  be 
inflated,  and  the  pubhc  will  be  given  a 
false  statement  as  a  basis  for  credit.  In 
the  case  of  the  formation  of  a  stock  com- 
pany, the  volume  of  issued  shares  purports 
to  have  some  relation  to  this  balance  or 
equity,  and  the  laws  of  most  states  declare 
that  such  shall  be  the  case.  The  fact  is, 
however,  that  there  are  many  ways  of  get- 


54    Accounting  for  the  Business  Man 

ting  around  these  provisions  and  many  pre- 
texts for  doing  so,  notably  the  much  abused 
"  capitalisation  of  earning  power."  Instead 
of  a  balance  sheet  equity  determining  the 
amount  of  shares  to  be  issued,  the  volume 
of  earnings  for  a  greater  or  less  period  is 
calculated,  and  this  amount  averaged 
among  the  years  it  covers.  Then  the  aver- 
age annual  income  is  capitalised.  In  other 
words  the  amount  is  divided  by  as  many 
hundredths  as  are  equivalent  to  the  rate  of 
dividends  which  the  promoters  promise  to 
investors.  The  figure  thus  reached  is  usu- 
ally much  higher  than  a  balance  sheet  equity 
would  be,  and  the  whole  or  a  part  of  the 
enterprise  is  disposed  of  at  a  figure  in  excess 
of  that  at  which  the  promoters  have  op- 
tioned or  purchased  the  property.  In  this 
case  some  fictitious  entry  will  be  found  on 
the  left  side  to  bring  the  apparent  equity  up 
to  par  with  the  amount  of  issued  shares. 
The  practical  remedy  will  be  the  prevention 
of  the  assignment  of  a  nominal  or  par  value 
to  the  shares,  and  the  consequent  necessity 
of  ascertaining  their  actual  value  before 
purchasing.    In  that  case  to  represent  them 


Opening  the  Ledger  55 

as  worth  a  certain  price  would  be  equivalent 
to  a  positive  statement  either  that  the  bal- 
ance sheet  equity  warranted  the  figure  or 
that  it  had  nothing  to  do  with  it.  In  either 
case  the  careful  investor  would  desire  to 
know  what  that  equity  really  was,  and, 
knowing  into  how  many  shares  it  had  been 
divided,  could  easily  decide  what  he  would 
be  willing  to  pay  for  them.  It  is  not 
claimed  that  inflation  would  cease,  merely 
that  it  would  become  necessary  to  he  a  little 
more  openly  and  with  a  little  less  support 
from  established  and  time-honoured  custom. 

It  is  the  purpose  of  this  chapter  not  only 
to  explain  the  steps  of  opening  a  set  of 
books,  but  to  emphasise  the  importance  of 
doing  it  rightly,  and  to  show  the  bearing  of 
the  method  adopted  upon  other  interests. 

The  most  important  part  of  the  work  is 
done  when  the  list  has  been  made  and  the 
owners  credited  with  the  equity.  This 
entry  may  be  made  under  any  of  a  large 
number  of  captions,  as  the  name  of  the 
individual  or  the  separate  names  of  two 
or  more,  showing  the  portions  belonging  to 
each  opposite  their  respective  names,  or  a 


56    Accounting  for  the  Business  Man 

term,  like  investment,  or  capital  account, 
may  be  used.  In  the  case  of  a  capitalised 
enterprise  the  usual  custom  is  to  use  the 
term  capital  stock,  or  if  there  are  two  or 
more  classes  of  shares,  to  use  a  designating 
title  and  enter  the  amount  of  each  sepa- 
rately. If  any  portion  of  the  shares  re- 
mains unsold,  an  off -setting  entry  is  made 
on  the  left  or  debit  side  under  the  title 
treasury  stock  and  the  par  "  value  "  of  such 
shares  set  down  among  the  assets.  It  is  not 
an  asset.  It  merely  neutralises  the  effect  of 
too  large  an  entry  as  the  hability  of  the 
business  to  its  owners;  and  helps  to  con- 
fuse them  in  any  effort  they  may  make  to 
ascertain,  from  a  scrutiny  of  the  balance 
sheet,  the  real  value  of  the  equity. 

The  remainder  of  the  operation  is  purely 
clerical.  Any  ledger  may  be  used,  a  page 
or  part  page  being  set  aside  for  each  item 
on  the  list,  and  named  accordingly.  The 
figures  opposite  the  various  names  in  the 
list  are  introduced  on  the  side  of  the  ledger 
page  corresponding  to  that  on  which  they 
appear  on  the  list.  The  date  is  entered,  and 
any  desirable  particulars   written  in.     If 


Opening  the  Ledger  57 

subsidiary  ledgers  are  to  be  operated,  those 
accounts  on  the  list  which  belong  to  each 
are  totalled  and  the  amount  entered  in  a 
governing  or  controlling  account,  as  already 
described. 

All  that  remains  is  to  enter  such  ac- 
counts similarly,  but  in  detail,  of  course, 
in  the  subsidiary  ledgers,  and  to  decide  upon 
the  forms  of  books  of  original  entry. 

The  process  described  in  this  chapter 
should  be  carefully  carried  out  before  pro- 
ceeding with  the  business.  The  manner  in 
which  it  is  carried  out  is  of  great  and  vital 
importance  and  it  should  be  one  of  the 
first  activities  of  the  owners  or  their  repre- 
sentatives to  see  that  this  has  been  done, 
not  only  with  promptness  and  accuracy,  but 
with  fairness  to  all  concerned.  It  should 
never  be  delegated  to  any  one  individual. 
It  may  safely  be  said  that  the  board  of 
directors  that  fails  at  its  first  meeting  to 
vgo  thoroughly  into  these  questions  begins 
its  career  with  a  failure  in  one  of  its  most 
vital  functions,  and  lays  a  foundation  for 
future  weakness  in  its  conduct  of  the  affairs 
of  the  business. 


CHAPTER  V 

CLOSING  THE  LEDGER 

THE  operation  of  closing  the  ledger  is 
second  in  importance  to  the  opening, 
only  because  there  is  not  so  great  oppor- 
tunity for  gross  error  and  misrepresenta- 
tion, providing  the  opening  has  been  prop- 
erly made.  This  is  true  because  any  dis- 
proportionate change  of  the  ratio  between 
total  assets  and  total  liabilities  during  a 
given  period,  if  not  too  long,  is  likely  to 
arouse  the  curiosity  of  some  one.  Let  it 
not  be  supposed  that  the  closing  may  be 
neglected  safely,  however,  even  when  the 
opening  is  known  to  have  been  properly  and 
honestly  made,  and  the  larger  the  capital 
invested  the  more  important  becomes  the 
scrutiny  of  every  step  in  the  operation,  both 
because  the  closing  in  itself  affords  oppor* 
tunity  for  inaccuracy  and  because  the  net 

result  as  shown  thereby  should  be  suggest- 
as 


Closing  the  Ledger  59 

ive  of  many  things  regarding  the  manner 
of  handling  the  business  and  its  records  for 
the  period.  For  example,  if  the  final  bal- 
ance sheet  shows  a  loss,  or  a  smaller  profit 
than  seems  reasonable  considering  the 
known  margin  of  gross  profits  over  prime 
cost  of  purchase  or  production,  there  may 
have  been  an  erroneous  or  deliberate  sys- 
tematic mishandling  of  the  business  or  of 
the  accounts.  The  former  would  be  most 
likely  to  appear  in  the  general  expenses. 
Extravagance  or  worse  than  that  may 
have  been  making  away  with  funds  which 
belong  to  the  owners  and  should  appear  in 
the  final  balance  sheet  in  accretions  to  their 
capital  for  the  period.  The  latter  should 
be  looked  for  in  the  charging  to  expense 
accounts  of  sums  of  money  legitimately 
chargeable  to  some  form  of  investment  and 
therefore  properly  showing  on  the  balance 
sheet  as  such  accretions.  The  individual 
owner,  managing  his  ow^n  business,  has  no 
particular  motive  for  such  courses,  beyond 
the  evasion  of  taxes,  perhaps;  but  where 
there  are  several  owners,  or  where  the  en- 
terprise, be  it  a  stock  company  or  not,  is 


60    Accounting  for  the  Business  Man 

managed  by  others  than  the  owners,  there 
may  be  various  motives.  The  most  common 
is  a  desire  to  reduce  the  apparent  value  with 
a  view  to  subsequent  purchase.  An  exam- 
ple of  this  would  be  the  building  of  ma- 
chinery to  increase  the  output,  charging 
the  labor  and  material  to  expense  accounts 
instead  of  investment  accounts.  One  of 
New  England's  most  prominent  enter- 
prises was  so  dealt  with  only  a  few  years 
ago.  The  representatives  of  the  original 
owner  on  the  board  were  honourable  and 
able  men,  but  so  uninformed  on  the  sub- 
ject of  accounting  possibilities  that  the 
managers  kept  them  for  years  in  ignorance 
and,  when  their  plans  were  ripe,  effected 
their  purpose,  and  made  a  large  profit  on 
the  operation  for  themselves  and  for  the 
New  York  and  Boston  "  financiers  "  who 
helped  them  carry  the  transaction  through. 
On  the  other  hand,  there  are  as  fre- 
quently motives  for  inflation,  and  the  dif- 
ficulty attendant  upon  neither  operation 
is  very  great,  while  detection  is  a  prac- 
tical impossibility  unless  adequate  knowl" 
edge  of  the  science  of  accounting  and  a 


Closing  the  Ledger  61 

motive  to  its  use  happen  to  be  in  the  proper 
quarter  and  supported  by  adequate  au- 
thority. This  is  the  point  at  which  the 
employment  by  various  interests  of  com- 
petent and  responsible  accountants  to  repre- 
sent them  in  boards  of  directors  becomes  an 
insurance  against  error  and  maladministra- 
tion. Such  working  directors  should  be  well 
paid  so  long  as  the  enterprise  is  successfully 
and  honestly  conducted,  and  should  be  dis- 
missed and  publicly  denounced  when  they 
fail  to  live  up  to  the  highest  possible  stand- 
ard of  responsibility.  It  is  peculiarly  true 
of  this  relation  that  the  greatest  asperity  of 
judgment  of  a  man's  conduct  is  the  best 
means  of  elevating  and  dignifying  his  pro- 
fession. The  accountants  of  the  country 
should  be  hke  our  judges,  indifferent  to 
abnormal  gains  for  themselves,  and  abso- 
lutely incorruptible. 

The  closing  consists  of  making  a  list  of 
all  the  account  balances  from  the  whole 
ledger  system,  or  from  the  governing  ledger 
if  there  be  one  (because  it  contains  certain 
accounts  which  epitomise  the  other  ledgers) . 
Then  from  this  list  or  trial  balance,  make  a 


62    Accounting  for  the  Business  Man 

new  list  which  shall  show  every  account 
that  represents  anything  owned  or  owed, 
even  including  those  accounts  whose  face 
value  is  not  the  same  as  the  value  of  the 
thing  represented. 

For  example,  the  old-fashioned  mer- 
chandise account  showed  a  balance  which 
was  made  up  of  three  elements,  two  on 
the  debit  side  and  one  on  the  credit  side. 
First  there  was  the  value  of  the  merchan- 
dise, or  inventory  with  which  the  period 
began;  then  there  were  the  two  contem- 
poraneous elements  of  sales  and  purchases 
on  the  credit  and  debit  sides  respectively. 
The  balance  was  the  difference  between  in- 
ventory plus  purchases,  and  sales.  Obvi- 
ously, if  all  these  items  were  priced  alike, 
the  balance  of  the  account  would  represent 
the  value  of  merchandise  on  hand  at  the 
close  of  the  period;  but  no  profit  on  sales 
would  have  been  made.  This  difference  in 
price  at  which  the  sales  are  entered  is  the 
source  of  profit  or  revenue.  The  total 
volume  of  it  represents,  on  a  paying  busi- 
ness, the  amounts  which  have  been  laid  out 
for  expenses  of  operation  and  the  amount  of 


Closing  the  Ledger  68 

accretion  to  the  excess  of  assets  over  Uabil- 
ities,  or  net  profit.  In  making  up  the  bal- 
ance sheet  this  margin  must  be  eliminated, 
and  the  merchandise  must  be  entered  at  its 
actual  present  volume  and  value.  If  it 
were  possible  to  know  the  total  of  the  credit 
side  of  the  account,  priced  as  the  debit  side 
is  priced,  that  figure  could  be  substituted 
for  the  credit  side  of  the  account  and  a  new 
balance  found  which  should  represent  the  in- 
ventory. Except  where  a  very  correct  cost 
system  is  maintained,  and  material  prime 
costs  appHed  in  posting  sales,  this  is  a  me- 
chanical impossibihty  and  it  becomes  neces- 
sary to  make  up  a  physical  inventory  of 
the  merchandise  on  hand.  Where  the  sales 
have  been  made  at  an  advance,  however 
small,  over  cost  and  purchases  have  been 
normal,  this  inventory  figure  will  be  larger 
than  the  balance  of  the  account  (except 
sometimes  in  manufacture  where  there  may 
be  a  very  great  discrepancy  in  volume  of 
goods  in  process,  etc.,  shown  in  the  two 
inventories).  This  excess  of  the  actual  in- 
ventory value  over  the  balance  of  the 
account  is  the  same  (leaving  out  of  account 


64    Accounting  for  the  Business  Man 

the  question  of  altered  pricing  and  losses 
through  damage,  theft,  etc.),  as  the  margin 
by  which  the  whole  volume  of  goods  sold, 
figured  at  selling  price,  exceeds  the  same 
volimie  of  goods  figured  at  cost  price,  and 
represents  the  gross  margin.  In  other 
words,  upon  revaluing  any  asset  repre- 
sented by  a  ledger  account,  if  the  inventory 
value  is  more  than  the  account  indicates, 
the  difference  represents  a  margin  of 
revenue.  For  the  balance  sheet  we  need 
actual  values  and  the  whole  list  should  be 
inspected  with  this  in  view,  including  those 
accounts  which  represent  other  values  than 
merchandise.  Many  of  them  may  have  de- 
creased, others  increasing,  while  others  re- 
main stationary  in  value. 

Having  made  this  list  of  assets  and  liabil- 
ities from  the  trial  balance,  correcting  the 
figures  to  make  them  represent  the  actual 
safe  values,  we  find,  if  there  has  been  either 
a  profit  or  a  loss,  that  we  have  a  statement 
which  does  not  balance.  Our  assets  and 
liabilities  were  in  balance  at  the  beginning, 
taking  into  account  the  entry  representing 
the  owner's  investment  (see  previous  chap- 


Closing  the  Ledger  65 

ter).  If  the  ratio  has  changed,  if  things 
owned  and  things  owed,  in  the  aggregate, 
have  increased  or  decreased  disproportion- 
ately, there  has  been  a  gain  or  a  loss. 
Obviously,  if  the  aggregate  assets  have  out- 
stripped the  aggregate  liabilities,  there  has 
been  a  gain  and  vice  versa. 

At  this  point  let  us  return  to  the  trial 
balance.  As  we  removed  balance  sheet 
items  therefrom,  we  checked  them  off.  If 
we  altered  a  balance  we  entered  a  com- 
pensating amount  and  left  the  item,  remov- 
ing only  the  changed  figure.  The  trial 
balance,  in  its  mutilated  condition,  presents 
a  list  of  accounts  and  parts  of  accounts 
which  have  been  discarded  in  making  up  the 
list  of  assets  and  liabilities.  They  are 
neither  one  nor  the  other.  Close  scrutiny 
shows  that  we  have  left  only  those  accounts 
which  represent  expenses  on  the  debit  side, 
and  those  which  represent  revenues  on  the 
credit  side,  chief  among  which  latter  stands 
the  compensating  entry  made  at  the  time  of 
the  substitution  of  merchandise  inventory 
for  the  balance  as  shown  by  the  merchan- 
dise account. 


66    Accounting  for  the  Business  Man 

For  example,  merchandise  account  bal- 
ance, $10,000  debit.  Inventory,  $15,000c 
The  substitution  of  the  latter  figure  on  the 
debit  side  calls  for  the  introduction  of  a 
compensating  or  offsetting  figure  on  the 
right  side.  Now,  removing  the  $15,000  item 
for  use  in  the  balance  sheet  we  have  a 
$5,000  item  left  on  the  credit  side  of  the 
mutilated  trial  balance.  We  have  main- 
tained the  balance,  because  we  have  added 
the  same  amount  to  both  sides.  It  being 
true  that  nothing  has  been  done  to  disturb 
the  balance,  it  is  obvious  that  the  two  sec- 
tions of  the  statement,  i.e.,  the  new  balance 
sheet  and  the  mutilated  trial  balance,  or  list 
of  revenues  and  expenses,  which  it  has  now 
become,  will  balance  if  again  incorporated 
into  one  statement.  Therefore  the  differ- 
ences shown  by  subtracting  the  lesser  foot- 
ings from  the  greater  will  be  identical  in  the 
two  statements,  but  on  different  sides.  If 
the  revenues  have  exceeded  the  expenses, 
the  assets  must  have  outstripped  the  liabil- 
ities, during  the  period.  The  revenues  have 
only  two  places  to  go.  They  can  go  only 
to  paying  expenses  and  to  changing  the 


Closing  the  Ledger  67 

ratio  between  assets  and  liabilities.  If  they 
are  more  than  adequate  to  the  former,  this 
fact  will  appear  not  only  in  a  comparative 
list  of  revenues  and  expenses,  but  it  must 
also  appear  in  a  comparative  list  of  assets 
and  liabilities  as  affected  by  the  operations 
of  the  period. 

At  this  point  it  is  well  to  stop  again  and 
note  the  opportunity  which  tliis  process  af- 
fords for  error  in  showing  the  results  of  the 
period.  Every  cent  erroneously  charged  as 
between  asset  and  expense  accounts  affects 
.this  showing,  and  every  error  in  making 
up  the  inventories  which  are  to  be  substi- 
tuted for  the  account  balances  also  affects 
it  directly.  In  every  step  of  the  process 
there  is  chance  for  inaccuracy,  but  particu- 
larly in  the  making  of  a  detail  valuation  or 
inventory  of  a  large  mass  of  varied  and  small 
items  of  merchandise.  Here,  with  the  best  in- 
tentions, accuracy  is  very  difficult,  and  con- 
versely, systematic  deception  is  very  easily 
hidden  and  very  effective,  either  in  unduly 
improving  or  impairing  apparent  results. 

These  two  statements  having  been  made 
and  their  accuracy  determined,  the  next  step 


68    Accounting  for  the  Business  Man 

is  to  close  all  of  the  items  of  the  expense  and 
revenue  statement  into  some  suitable  ac- 
count provided  for  the  purpose,  by  entering 
the  amount  each  ledger  account  shows  on 
the  opposite  side  of  that  account,  at  the 
same  time  entering  it  on  the  same  side 
in  this  closing  account  as  it  originally 
appeared  on  in  the  account  from  which  it 
comes.  This  process  completed,  we  have  in 
the  closing  account  an  exact  copy  of  the 
expense  and  revenue  statement.  We  have 
already  seen  that  the  difference  shown  by 
that  statement  was  equal  to  the  difference 
shown  by  the  balance  sheet  statement  but 
on  the  opposite  side.  Therefore  the  dif- 
ference of  this  new,  or  closing  account,  if 
entered  in  the  balance  sheet  statement  under 
the  caption  of  Loss  and  Gain,  as  used  to 
be  the  custom,  or  as  results  of  a  certain 
year,  or  as  surplus,  or  even  if  it  be  merely 
added  to  the  owner's  credit  account,  the  bal- 
ance sheet  will  balance;  we  shall  have  only 
asset,  liability,  and  capital  and  surplus  ac- 
counts open  on  the  ledger,  and  we  shall  be 
ready  to  proceed  to  another  period  of 
operation. 


CHAPTER  VI 

ACCOUNT   CHARACTERISTICS 

IN  most  things  an  exhaustive  understand- 
ing of  methods  is  impossible,  apart  from 
a  clear  understanding  of  the  reasons.  This 
is  true  of  accounting.  In  a  larger  sense, 
it  is  true  of  business  methods  generally, 
that  they  are  very  apt  to  be  loose  and  un- 
systematic, unless  founded  on  that  executive 
science  which  is  inseparable  from  a  more  or 
less  clear  grasp  of  accounting  reasoning. 
The  day  is  past  when  the  duty  of  the  execu- 
tive is  to  perform  a  part  of  every  function 
of  the  operating  force.  His  field  has  be- 
come more  systematic  and  scientific.  He  is 
no  longer  a  slave  driver  either,  and  he 
should  not  be.  It  is  his  province  to  devise 
plans  and  methods  which  shall  result  in 
more  effective  work  on  the  part  of  the  force, 
with  better  support  through  the  policy  of 
operating  the  business,  and  encouraged  by 
the  showing  which  he  lays  before  them  of 


70    Accounting  for  the  Business  Man 

what  is  being  accomplished.  None  of  this 
work  can  be  done  as  effectively,  supposing 
other  qualifications  to  be  equal,  by  the  man 
who  cannot  read  the  history  of  what  is  being 
done,  as  currently  recorded  in  the  accounts. 
Furthermore,  an  executive  who  is  not  thor- 
oughly versed  in  the  reasons  as  well  as  the 
methods  of  accounting  is  on  dangerous 
ground,  because  the  record  of  his  opera- 
tions is  being  made  in  a  language  which  he 
can  neither  read  nor  speak,  and  he  may  find, 
when  the  story  is  translated  to  the  owners, 
that  it  fails  to  corroborate  his  own  more 
general  statements.  The  showing  from  the 
books  is  more  likely  to  be  accepted  than  any 
other,  on  the  ignorant  theory  that  "  figures 
do  not  lie,"  and  this  showing  may  have  been 
made  unduly  unfavourable  through  igno- 
rance or  design  on  the  part  of  another  offi- 
cer, or  even  of  a  subordinate. 

The  insight  necessary  to  correct  reason- 
ing in  devising  methods,  and  to  proper 
supervision  of  the  records  at  the  time  of 
their  creation,  can  exist  only  where  there 
is  a  knowledge  of  the  subject  sufficiently 
acute  to  enable  the  executive  to  detect,  in- 


Account  Characteristics  71 

stantly  and  always,  the  effect  of  each  orig- 
inal entry  upon  the  final  showing  to  be 
made  by  the  balance  sheet. 

The  source  of  this  knowledge  is  careful 
analysis  of  the  character,  derivation,  and 
bearing  of  the  ledger  accounts.  The  cardi- 
nal principle  of  debit  and  credit  must  be 
clearly  in  mind.  Debit  or  charge,  and  enter 
on  the  left,  what  comes  in  or  costs  some- 
thing; credit,  and  enter  on  the  right,  what 
goes  out  or  produces  something.  It  is  also 
helpful  to  remember  that  accounts  were 
started  originally  from  an  outside  stand- 
point, not  from  the  standpoint  of  the  busi- 
ness. That  is,  John  Jones  buys  something. 
A  ledger  account  is  opened  for  John  Jones' 
account  with  the  business,  not  for  the  ac- 
count of  the  business  with  John  Jones. 
He,  the  outsider,  is  charged  on  our  books 
with  the  value  of  what  he  has  gotten. 
Under  the  operation  of  the  cardinal  prin- 
ciple, this  account  has  come  to  mean  a 
record  of  the  amount  of  John  Jones'  credit 
A^hich  has  come  into  our  hands,  or  cost  us 
something,  i.e.,  a  portion  of  merchandise  or 
other  valuable  thing.     On  the  account  oe 


72    Accounting  for  the  Business  Man 

accounts  representing  what  we  have  parted 
with  in  order  to  get  that  much  of  John 
Jones'  credit  into  our  possession,  we  credit 
an  equivalent  amount  and  the  transaction 
is  complete.  This  entry  has  nothing  to  do 
with  the  question  of  whether  we  shall  ever 
get  from  John  Jones  anything  more  tan- 
gible than  a  portion  of  his  good  name. 
Later  on,  if  he  pays,  cash  comes  in,  and  we 
part  with  that  portion  of  his  credit  which 
we  have  been  holding  as  one  of  our  assets. 
In  these  transactions  something  has  come  in, 
and  has  cost  us  something.  There  is  a  class 
of  transactions  where  we  part  with  some- 
thing, but  nothing  material  comes  in.  These 
are  the  transactions  of  payment  of  cash  or 
of  our  credit  for  expenses  of  the  character 
of  dues  and  wages.  These  payments  are 
necessary  to  operation,  but  require  most 
careful  watching,  both  to  prevent  extrava- 
gance, and  to  avoid  the  error  of  charging 
to  an  expense  account  outlays  which  ought 
to  appear  on  an  account  which  represents  a 
thing  which  has  come  in  as  well  as  has  cost 
us  something.  The  dangers  in  this  field 
have  already  been  mentioned.     There  are^ 


Account  Characteristics  73 

transactions  on  the  border  line  which  re- 
quire the  most  careful  watching.  (The  two 
places  in  the  machinery  where  the  most  of 
these  inaccuracies  occur  are  in  the  marking 
of  the  bills  before  they  are  entered  on  the 
purchase  journal,  and  in  the  distribution  of 
the  pay-roll,  explained  later.)  These  trans- 
actions consist  of  parting  with  something 
for  some  other  thing  which  may  appear  at 
first  glance  to  be  an  addition  to  values, 
while  in  reality  it  is  not,  and  vice  versa. 
For  example,  even  so  stable  an  article  as  a 
new  machine  may  be  an  expense  rather  than 
investment  if  it  is  to  replace  a  discarded 
one  of  similar  type  and  productiveness.  On 
the  other  hand,  an  apparently  evanescent 
thing  may  increase  the  value  of  some  invest- 
ment, or  a  purchase  of  supplies  may  be  very 
large,  for  speculative  purposes,  and  the  un- 
consumed  and  undeteriorated  balance  on 
hand  is  as  surely  an  asset  as  though  it  were 
material  for  manufacture  or  finished  goods 
for  resale.  This  is  one  of  the  favourite 
agencies  of  the  wrecker,  the  other  principle 
one  being  the  detail  inventory.  Indeed  the 
two  methods  are  identical  except  in  their 


74    Accounting  for  the  Business  Man 

mode  and  tense.  Another  point  which 
should  be  touched  upon  here,  but  which  we 
shall  discuss  more  fully  later,  is  the  neces- 
sity of  diminishing  the  volume  of  any  invest- 
ment when  for  any  reason  it  shall  have 
become  actually  less  valuable  than  it  was  at 
the  time  of  recording  it.  We  have  already 
mentioned  this  matter  in  discussing  the 
closing  of  the  ledger.  It  is  just  as  impor- 
tant to  increase  the  recorded  value  when  the 
actual  value  substantially  and  permanently 
increases  (in  order  that  the  improvement 
may  show  in  the  period  to  which  it  belongs) 
unless,  for  good  reason,  and  with  the  con- 
sent of  all  interests  it  shall  be  deemed  wiser 
to  carry  investments  at  less  than  actual 
values.  The  method  of  doing  all  of  these 
things  will  be  explained  in  the  chapter  on 
reserves,  etc. 

Obviously,  in  railroad  and  other  heavy 
construction,  there  is  great  opportunity  for 
inaccuracy  in  these  matters.  In  banking 
and  financial  enterprises  the  necessity  of 
close  and  careful  attention  is  very  great,  on 
account  of  fluctuations  of  values  of  invest- 
ments.    Mining  values  are  especially  sus- 


Account  Characteristics  75 

ceptible  to  change.  For  example,  a  heavy 
development  investment  may  suddenly  be- 
come valueless  through  the  disappearance 
of  the  ore  body,  or  an  unexpected  difficulty 
of  mining  or  treating,  rendering  the  proc- 
esses too  expensive  to  be  profitable.  The 
question  should  be  constantly  present,  what 
are  our  investments  actually  worth  now? 
It  makes  no  difference  what  they  were 
worth  when  recorded. 

This  distinction  between  investment  and 
operating  expense,  and  how  to  create  and 
maintain  it  in  the  records,  should  be  very 
clear  to  the  management,  because  of  its 
bearing  upon  the  pohcy  and  story  of  the 
business. 

The  cash  account  is  susceptible  of  no 
inaccuracies  of  the  character  above  men- 
tioned either  in  entries  or  inventories,  and 
only  in  vakiation  in  the  event  of  some  such 
unusual  condition  as  a  premium  upon  gold, 
or  the  discovery  of  a  defalcation.  A  dollar 
comes  in.  It  can  be  charged  to  nothing  but 
cash.  Cash  can  be  nothing  but  an  asset,  and 
is  not  normally  subject  to  depreciation  in 
value  wliile  on  hand. 


76    Accounting  for  the  Business  Men 

Accounts  receivable  have  a  less  stable 
character,  and  should  not  be  accepted  at 
face  value  without  investigation.  There  is, 
of  course,  no  opportunity  for  confusion  with 
expense,  but  even  when  the  work  of  the 
credit  department  has  been  properly  done 
many  uncontrollable  causes  may  arise,  lead- 
ing to  a  depreciation  of  their  value.  It  is 
customary  to  meet  the  probabilities  in  this 
direction  by  regular  entries  of  a  certain 
percentage  on  a  reserve  against  losses.  In 
addition  a  periodical  scrutiny  is  desirable. 
This  can  be  made  almost  automatic  by 
the  estabUshment  of  some  such  collection 
system  as  that  outhned  in  a  subsequent 
chapter. 

Notes  or  bills  receivable  we  have  pur- 
posely avoided  in  our  effort  to  grasp  undei- 
lying  principles,  with  as  little  detail  analysis 
as  possible.  John  Jones,  above  mentioned, 
finds,  when  the  day  comes  for  the  payment 
of  his  account  on  our  books,  that  his  cash  is 
not  very  plentiful.  He  thinks  that  we  may 
need  the  money,  and  he  knows  that  it  is  an 
awkward  process  for  us,  and  frequently  an 
unsuccessful   attempt,   to   take   his   ledger 


Account  Characteristics  77 

page  to  our  bank  and  get  a  loan  on  it  as 
security.  He  knows  that  our  chance  at  the 
bank  would  be  better  if  he  wrote  on  that 
page,  "  I  owe  the  above  amount,  it  was  for 
value  received,  and  I  will  pay  it "  on  de- 
mand, or  a  certain  length  of  time  after  date. 
This  he  approximates  by  writing  a  syn- 
onymous statement  on  a  note  form  and 
sending  it  to  us  to  hold,  or  to  use  as  we  see 
fit.  If  there  is  to  be  a  further  lapse  of  time 
before  payment,  it  is  frequently  better  to 
have  such  signed  evidence  of  the  debt,  and 
furthermore  such  notes  usually  are  made 
interest-bearing.  From  the  standpoint  of 
our  accounting,  his  action  has  resulted  in 
wiping  out  our  hold  upon  his  credit  in  the 
form  in  which  it  appeared  on  the  open  book 
account,  and  giving  it  to  us  in  another  form. 
We  must  therefore  offset  the  charges  on 
that  book  account  by  crediting  this  note 
(the  entry  is  made  in  the  adjusting  jour- 
nal). There  must  be  a  balancing  entry  on 
the  left  or  debit  side  of  some  account.  We 
might  carry  a  separate  account  for  each 
such  note  received,  but  that  is  unnecessary, 
because,  unlike  the  book  account,  or  credit 


78    Accounting  for  the  Business  Man 

account  of  John  Jones,  which  is  being  in- 
creased by  daily  purchases,  perhaps,  this 
is  a  complete  transaction.  The  face  of  it 
will  not  be  altered.  Therefore  we  open  an 
account  which  we  call  notes  or  bills  receiv- 
able, and  enter  this  and  all  other  such  notes, 
regardless  of  whom  they  may  come  from,  in 
the  same  account.  This  account  might  be 
called  "  a  ledger  account  showing  all 
amounts  which  have  been  transferred  from 
debtors'  open  accounts  to  debtors'  accounts 
evidenced  by  written  acknowledgments 
thereof  with  stated  date  of  promised  pay- 
ment." This  account  varies,  in  its  handling, 
from  the  others,  by  the  fact  that  the  line 
on  the  credit  side  of  the  page  opposite  the 
debit  entry  is  left  blank  until  the  note  is 
sold  or  paid,  when  this  line  is  used  to  make 
the  entry.  In  arriving  at  a  balance  of  this 
account  it  is  necessary,  naturally,  always  to 
add  the  whole  of  the  credit  side.  Old  foot- 
ings cannot  be  trusted  because  of  the  fact 
that  a  former  blank  line  may  have  been 
filled  in  the  interim.  In  passing,  let  the 
reader  avoid  confusing  this  account  with  the 
auxiliary  record  which  is  kept  for  the  sake 


Account  Characteristics  79 

of  more  complete  detail  than  appears  on 
the  ledger.  Many  executives  also  enter  due 
dates  on  a  reminder  diary  so  as  to  be 
promptly  informed  of  delinquencies.  In 
financing,  it  is  always  well  to  reckon  the 
difference  made  or  lost  on  interest  by  hold- 
ing these  notes  or  selling  them. 

This  account,  like  the  two  just  discussed, 
is  immune  from  confusion  with  expense 
accounts  in  entering  the  charges,  but  it  re- 
quires very  careful  scrutiny  and  revalua- 
tion or  inventory  from  time  to  time,  par- 
ticularly if  there  be  many  entries  or  long 
periods.  Furthermore,  the  sale  of  such 
notes  usually  involves  their  indorsement,  i.e., 
we  must  sign  our  name  on  them  (usually  on 
the  back)  as  guaranteeing  their  value.  Our 
bank  may  not  know  the  maker  of  the  note, 
or  the  endorser  if  it  be  "  two  name  "  paper, 
hence  our  name  must  also  be  added.  Our 
responsibility  does  not  cease  until  the  maker 
finally  pays  the  note,  therefore  the  careful 
manager,  through  his  credit  department,  will 
continue  to  watch  it,  and  the  condition  and 
conduct  of  the  maker.  Co-operation  in 
dealing  with  the  object  of  this  account,  and 


80    Accounting  for  the  Business  Man 

the  credit  back  of  it,  between  the  whole 
community  of  banks  and  of  business  organ- 
isations, will  be  the  only  safe  foundation  on 
which  to  build  a  proper  banking,  currency, 
and  commercial  system  for  this  country. 

Plant  accounts  are  susceptible  to  depre- 
ciation, both  through  deteriorations  of  build- 
ings and  decrease  in  value  or  availability 
of  real  estate.  On  the  other  hand,  buildings 
may  be  greatly  improved  in  value  by  cer- 
tain expenditures,  and  even  rendered  more 
permanent  and  lasting  (for  example,  con- 
creting foundations  or  cementing  floors  and 
walls).  The  value  of  the  real  estate  may 
enhance  greatly  and  even  suddenly.  This 
account  requires  careful  watching. 

Machinery,  including  power  plant,  is  a 
subject  for  the  most  expert  and  careful 
analysis,  because  there  are  so  many  elements 
to  consider.  First  is  the  wear  and  tear ;  sec- 
ond, the  state  of  the  art,  that  is,  the  inven- 
tion and  possible  adoption  by  ourselves  or 
our  competitors  of  better  and  less  costly 
processes  for  producing  the  same  result; 
third,  the  demand  of  the  trade  and  the 
prices  which  competition  may  have  created. 


Account  Characteristics  81 

It  would  require  the  pen  of  an  engineer  to 
do  justice  to  this  subject,  in  addition  to  all 
that  might  be  said  by  the  executive,  and  the 
result  would  be  a  volume  of  considerable 
size.  These  statements,  thoughtfully  con- 
sidered, would  seem  to  imply  that  there  is 
opportunity  for  inaccuracy  in  charging  new 
outlay,  as  between  investment  and  expense. 
The  inference  is  correct,  and  the  proper 
handling  of  the  matter  depends  upon  an 
exhaustive  knowledge  of  technicahty  in  the 
business  in  question  as  well  as  of  account- 
ing science.  Frequently  it  is  necessary, 
where  no  one  man  possesses  a  comprehen- 
sive working  knowledge  of  all  these  mat- 
ters, to  call  together  the  mechanical  heads 
directly  concerned  and  the  members  of  the 
sales  force  directly  affected  by  the  output, 
and  question  all  closely,  from  their  own 
standpoint,  not,  of  course,  from  the  stand- 
point of  accounting.  From  the  operating 
department  we  must  know  what  effect  the 
outlay  has  upon  volume  and  cost  of  pro- 
duction; from  the  salesman  we  must  learn 
the  demand,  the  attitude  of  rival  institu- 
tions, and  the  probability  of  price  change? 


82    Accounting  for  the  Business  Man 

under  improved  methods.  The  executive 
must  possess  the  knowledge  of  why  he  asks 
these  questions;  in  other  words,  he  must 
understand  the  bearing  upon  them  of  scien- 
tific accounting  principles.  Many  a  con- 
cern has  been  reduced  from  busy  affluence 
to  innocuous  desuetude  in  a  period  of  years 
during  which  the  returns  available  for 
dividends  have  been  unconsciously  and  un- 
intentionally inflated  by  a  failure  on  the 
part  of  executives  to  see  the  effect  upon 
machinery  investment  of  progress  in  the  art. 
The  value  has  been  kept  up  in  the  balance 
sheet,  large  profits  have  been  shown,  and 
funds  which  should  have  been  reserved  for 
improvements  and  replacements  have  been 
paid  out  in  dividends.  All  this  can  be  pre- 
vented by  the  executive  who  acts  on  sound 
principles,  and  is  content  to  have  his  reward 
in  heaven.  From  the  owners'  standpoint, 
the  strongest  of  all  objections  to  a  profit 
percentage  contract  with  managers  lies  in 
this  field.  Its  dangers  can  be  forestalled  by 
a  properly  drawn  contract,  reinforced  by 
adequate  auditing  of  the  charges  by  a  com- 
mittee of  the  board  of  directors.    The  fiasco 


Account  Characteristics  83 

of  the  institution  previously  mentioned 
would  probably  not  have  occurred  if  the 
managers  had  been  allowed  a  percentage  of 
profits,  and  their  accounting  competently 
audited.  It  would  have  been  their  motive 
to  make  too  good  a  showing  rather  than  a 
poor  one,  and,  with  this  properly  checked, 
the  result  would  have  been  greatly  to  the 
owners'  advantage.  A  matter  closely  con- 
nected with  all  these  considerations,  is  the 
tendency  to  ossification  of  the  organisation. 
Each  department  sees  its  own  functions 
only,  and  is  very  loath  to  alter  them  for 
the  benefit  of  any  other.  This  shows  on  the 
records  only  when  we  compare  productive- 
ness and  costs  with  corresponding  items  in 
other  and  more  progressive  departments  or 
enterprises.  Sometimes  the  only  oppor- 
tunity for  this  comparison  hes  in  inference 
from  the  salesman's  report  of  what  com- 
petitors are  doing. 

Inventories  of  materials  or  merchandise, 
and  inventories  of  supplies  in  excess  of  cur- 
rent consumption,  are  of  such  character  that 
it  has  always  been  customary  to  analyse 
them  more  or  less  carefully  at  least  once 


84f    Accounting  for  the  Business  Man 

a  year,  since  the  passing  of  the  time  when 
a  rough  survey  of  a  little  store  was  suffi- 
cient to  disclose  the  condition  of  the  stock. 
It  is  impossible  to  treat  it  with  so  great 
indifference  as  the  other  inventories.  In- 
deed a  great  deal  has  been  done  toward 
securing  more  and  more  frequent  additions 
of  it,  either  by  recording  its  flow  in  terms  of 
cost,  or  by  ascertaining  a  reasonable  aver- 
age ratio  between  consumption  and  some 
constant,  as  direct  labour.  There  are  two 
plans  for  recording  the  flow;  a  strict  ware- 
housing system,  and  the  application  of  cost 
figures  to  the  detail  sales  record.  Either 
is  apt  to  be  cumbersome,  but  can  hardly  fail 
to  be  profitable.  There  are  few  concerns, 
however,  except  those  properly  organised  at 
the  outstart,  where  either  is  instantly  pos- 
sible. The  resort  is  of  necessity  to  a  system 
of  ratios.  This  properly  belongs  in  a  dis- 
cussion of  the  operation  of  an  inventory 
ledger,  and  will  be  explained  in  another 
chapter.  There  is  every  opportunity  for 
inaccuracy  in  making  charges  as  between 
these  accounts  and  the  expense  accounts, 
and  one  great  source  of  power  for  good  or 


Account  Characteristics  85 

evil  in  the  conduct  of  a  business  is  the  con- 
trol of  these  inventories.  Their  infinite  de- 
tail renders  the  auditing  of  them  a  discour- 
aging task,  but  it  can  and  should  be  done, 
and  there  are  many  means  of  precaution, 
chief  among  which  is  the  assignment  of  de- 
partments to  different  groups  of  men  each 
year,  and  the  careful  recording  of  a  pricing 
system. 

Investments  in  things  other  than  the 
legitimate  object  of  trade  require  especial 
attention,  as  real  estate  taken  for  debt,  etc., 
etc.  The  question  of  value  is  omnipresent 
in  financial  business  and  calls  for  no  ex- 
tended comment  here. 

Another  item  which  frequently  appears 
among  the  assets  is  the  deferred  charge  for 
some  outlay  which  is  expected  to  produce 
results  over  a  longer  period  than  the  single 
fiscal  one,  and  hence  ought  not  to  be  in- 
cluded as  a  whole  in  the  expense  of  the 
period  in  which  it  was  made.  In  a  very 
true  sense  this  is  an  asset,  because  it  is  an 
agency  working  for  the  good  of  the  busi- 
ness, although  it  is  less  concretely  realisable 
than  cash  or  merchandise.    It  will  be  treated 


86    Accounting  for  the  Business  Man 

fully  in  the  chapter  on  reserves.  An  ex- 
pensive catalogue  is  an  example. 

The  only  other  items  appearing  regularly 
among  assets  are  treasury  stock  and  de- 
ficiency accounts  (old-fashioned  gain  and 
loss  on  the  wrong  side).  The  former  is  in 
no  way  concerned  with  the  discussion  of 
depreciation  and  valuation,  being  merely 
an  offset  to  that  portion  of  the  capital 
stock  account  which  remains  unsold.  The 
latter  is  merely  a  balancing  entry  created 
from  the  record  of  an  excess  of  operating 
outlay  over  revenue  during  a  former  period 
of  the  business  which  began  without  suffi- 
cient surplus  to  cover  that  excess.  The  only 
way  in  which  it  can  "  depreciate  "  is  by  a 
period  of  successful  operation.  Managers 
generally  dislike  to  make  such  a  showing, 
and  can  easily  avoid  it  in  the  handling  of 
inventories.  A  business  which  appears  to 
stand  still  for  a  considerable  period  should 
be  carefully  investigated  with  this  fact  in 
mind. 

On  the  credit  side  we  have  what  we  owe, 
accounts  and  notes  payable,  neither  of  which 
is  subject  to  the  kind  of  depreciation  we 


Account  Characteristics  87 

have  been  discussing.  We  also  have  the 
capital  stock  or  owners'  accounts.  These 
accounts  represent,  as  we  have  already  seen, 
the  equity  in  the  business,  and  fluctuate  in 
value  with  the  loss  or  gain  on  the  business, 
less  the  amounts  paid  out  in  dividends.  The 
surplus  account  has  already  been  explained 
in  the  chapter  on  closing. 

In  addition  to  all  these  there  is  some- 
times on  the  debit  side  an  account  of  doubt- 
ful meaning  and  value.  It  may  be  called 
by  a  variety  of  names.  Good  will  is  a 
representative  name  applied  to  this  account, 
and  its  purpose  is  to  offset  capitalisation  at 
more  than  the  equity  in  the  business.  An- 
other accoimt  used  for  the  purpose  of  keep- 
ing the  current  period's  operations  free  from 
losses  and  expenses  really  belonging  to  the 
past  is  called  "loss  and  gain,  or  results 
previous  to  present  fiscal  period."  The 
balance  of  this  account  may  be  a  debit  or 
a  credit  one,  as  the  preponderance  of  these 
surprise  items  chances  to  be  unfavourable  or 
favourable. 

The  distinction  between  assets  and  ex- 
penses should  be  sufficiently  clear  without 


88    Accounting  for  the  Business  Man 

going  into  detail  here  regarding  the  latter. 
From  the  standpoint  of  this  discussion  of 
asset  accounts,  all  expense  accounts  are 
exactly  alike.  Every  charge  to  any  of  the 
expense  accounts  will  come  out  of  the 
revenue,  or  add  to  the  deficit  of  the  period. 
If  it  be  an  item  which  really  belongs  among 
the  assets,  its  inclusion  in  an  expense  ac- 
count will  make  the  owner  appear  to  be  just 
that  much  less  opulent,  when  the  balance 
sheet  shall  be  drawn  oflf.  There  is  little 
chance  for  confusion  between  liability  ac- 
counts and  operating  revenues  because  of 
the  intrinsic  characteristics  of  these  two 
classes,  and  because  sinister  motives,  where 
they  exist,  can  be  more  easily  disguised 
among  the  items  on  the  opposite  side.  One 
point  regarding  liability  accounts  which  re- 
quires auditing  in  some  instances,  however, 
is  the  creation  of  accounts  which  do  not 
exist,  or  the  inflation  of  accounts  for  the 
purpose  of  collusive  advantage  to  two  or 
more  operators,  one  of  whom  must  belong 
to  the  accounting  and  buying  organisa- 
tion while  the  others  have  a  foothold  in 
the  accounting  and  selling  organisation  of 


Account  Characteristics  89 

the  house  in  whose  name  the  account 
stands. 

Reserves  complete  the  list  on  the  credit 
side,  and  will  be  taken  up  later.  A  sink- 
ing fund  account  may  also  be  carried  where 
the  amount  is  retained  in  the  bank  balance 
or  actually  set  aside  or  invested  in  safe 
securities. 

One  object  of  the  application  of  such 
close  reasoning  to  the  recording  of  the 
current  history  of  a  business  lies  in  the  fact 
that  it  affords  the  executive  the  weapon 
necessary  to  prevent  drawing  out  of  the 
business  in  dividends  more  of  its  Ufe  blood 
than  is  consistent  with  continued  or  increas- 
ing activity.  It  is,  at  the  same  time,  the 
only  way  of  telling  the  actual  truth  about 
the  operations  and  present  values.  A  com- 
prehension of  correct  methods  makes  it  pos- 
sible to  do  both  at  the  same  time,  for  the 
amount  of  available  money  and  anticipated 
necessary  investments  and  expenditures  can 
be  brought  into  the  discussion  by  a  report 
supplementing  the  balance  sheet  and  treat- 
ing of  the  subject  in  terms  of  scientific 
accounting. 


CHAPTER  VII 

VALUATION  AND  RESERVES 

WE  have  considered  the  bearing  of  the 
original  entry  in  creating  a  correct 
record  of  values;  we  have  also  seen  that  it 
is  unsafe  to  rely  altogether  upon  the  original 
entry  as  a  means  of  maintaining  that  record. 
Some  reasons  have  been  given  for  the  care- 
ful endeavour  to  have  the  ledger  show  true 
values.  There  is  a  great  divergence  in  the 
opinions  of  sound  and  able  business  men  on 
this  question,  many  strongly  advocating 
ruthless  reduction  of  values.  The  advocates 
of  the  system  of  showing  correct  values 
urge  the  importance  of  this  for  insurance 
purposes,  maintaining  that  it  is  safer,  if  it 
comes  to  dealing  with  adjusters,  to  be  in  a 
position  to  show  the  values  carried  on  the 
ledger. 

A  proper  use  of  reserves  for  this  pur- 
pose, instead  of  cutting  down  the  account 
itself,  makes  it  possible  to  show  the  values 

90 


Valuation  and  Reserves  91 

and  at  the  same  time  derive  all  the  benefits 
of  the  most  strenuous  measures  for  prevent- 
ing too  heavy  a  drain  in  the  form  of  divi- 
dends. It  tells  the  whole  story  of  what  has 
been  done,  which  is  a  very  great  advantage, 
at  least  to  those  who  have  no  motive  for 
concealment. 

The  creation  of  a  reserve  is  very  simple. 
For  example,  it  has  been  decided  to  create 
a  reserve  of  a  certain  percentage  of  the  value 
of  the  buildings,  i.e.,  to  diminish  the  show- 
ing of  the  balance  sheet  by  an  amount  which 
shall  represent  the  supposed  depreciation, 
or,  regardless  of  depreciation,  the  desired 
reduction,  in  the  volume  of  the  account  that 
purports  to  show  the  value  of  that  invest- 
ment. The  old  way  is  to  make  an  entry  at 
the  end  of  the  year  exactly  identical  with 
that  explained  in  connection  with  the  crea- 
tion of  the  balance  sheet  from  the  trial 
balance,  where  an  inventory  showed  an  ac- 
count value  incorrect.  It  is  sometimes 
argued  that  this  system  does  not  remove  the 
possibility  of  determining  real,  or  original 
values  from  the  account.  Theoretically  this 
is  true,  but  practically  the   operation  be- 


92    Accounting  for  the  Business  Man 

comes  more  tedious  than  an  insurance  ad- 
juster will  undertake,  first  because  these 
entries  appear  among  a  diversity  of  other 
credits  (in  most  accounts),  and  second,  be- 
cause ledgers  must  be  renewed  constantly 
and  balances,  only,  are  usually  carried  for- 
ward. The  detail  is  therefore  eventually 
scattered  through  a  large  number  of  books, 
the  loss  of  some  of  which,  in  a  large  fire, 
is  almost  inevitable.  Furthermore  the  an- 
nual charging  off  of  decreases  in  valuation, 
or  depreciation,  has  a  serious  disadvantage 
where  it  is  the  purpose  (and  it  should  be 
always)  to  make  balance  sheets  or  approx- 
imations thereof  at  more  frequent  intervals. 
Unless  these  depreciation  charges  are  made 
monthly,  or  for  the  same  period  as  the  bal- 
ance sheets,  an  element  of  inaccuracy  neces- 
sarily enters. 

The  method  recommended  by  many  good 
accountants  is  this:  After  the  determina- 
tion by  competent  authority  of  the  ratios  of 
decrease  or  depreciation,  divide  this  ratio 
by  the  number  of  periods  at  which  it  is  pur- 
posed to  make  approximations  of  the  bal- 
ance sheet.     Apply  this  new  ratio  to  the 


Valuation  and  Reserves  98 

balance  of  the  account,  or  to  the  items,  in 
case  of  a  ditferent  ratio  for  different  items, 
and  in  the  book  of  entry  used  for  making 
adjusting  entries,  credit  "  reserve  for  depre- 
ciation "  of  plant,  or  other  asset  account, 
and  charge  the  amount  to  some  expense 
account.  The  debit  entry  can  be  made  to 
general  expense,  if  the  system  be  sufficiently 
old-fasliioned  to  carry  such  an  account; 
otherwise  it  becomes  desirable  to  open  a 
depreciation  expense  account  expressly  to 
provide  for  these  entries,  or,  where  the  ex- 
penses are  classified  closely  in  order  to  get 
percentages  of  classified  contingent  addi- 
tion to  prime  cost,  a  separate  expense  ac- 
count should  be  carried  to  correspond  to 
each  form  of  reserve.  The  credit  side  of 
this  entry  gradually  creates  an  account 
which  appears  among  the  liabilities,  al- 
though the  amount  is  not  owing  to  any 
one.  It  stands  there  merely  as  an  offset  to 
so  much  of  the  cost  of  the  particular  asset 
to  which  it  apphes.  It  is  a  reservation  from 
values  available  for  dividends  or  surplus, 
of  an  amount  decided  upon  for  the  purpose. 
Reserves  may  be  divided  into  three  main 


94    Accounting  for  the  Business  Man 

classes.  Those  necessitated  by  statute,  con- 
tract, or  experience  as  a  margin  of  safety; 
those  established  to  provide  for  a  known 
future  demand;  and  those,  like  the  one  just 
described,  to  reduce  account  valuations. 
Banks,  trust  companies,  and  insurance  com- 
panies are  much  concerned  with  the  first 
class.  Very  large  corporations  frequently 
go  into  the  matter  of  reserves  as  a  margin 
of  safety.  There  is  a  great  opportunity  for 
the  abuse  of  this  machinery  for  diminish- 
ing the  apparent  results  shown  by  the  bal- 
ance sheet,  where  conflicting  interests  and 
purposes  exist,  as  where  a  powerful  minority 
is  agitating  for  dividends.  It  is  to  this 
agency  that  large  corporations  will  look  for 
"  protection  "  from  the  exactions  of  a  tax 
on  net  income.  A  smaller  tax  on  gross 
income  might  be  more  effective.  In  any 
case,  the  government  will  need  to  know  the 
operation  of  this  subtle  influence  and  how 
to  meet  it.  It  is  by  the  skilful  manipulation 
of  this  account  that  "  good  will "  and  other 
accounts  created  to  offset  the  promoters' 
stock,  in  the  case  of  over-capitalisation,  are 
gradually  offset  from  the  profits  of  a  busi- 


Valuation  and  Reserves  95 

ness.  Whether  or  not  this  operates  unfairly 
to  the  interest  of  investors  depends  upon 
the  form  of  organisation,  and  other  condi- 
tions. An  instance  of  extreme  unfairness 
would  be  the  case  of  a  preferred  non- 
cumulative  limited  dividend  stock  redeem- 
able at  the  option  of  the  company,  with 
voting  power  in  the  common  stock  only. 
Dividends  on  the  preferred  are  passed  for 
a  period  during  which  the  balance  sheet 
shows  no  profits,  owing  to  the  setting  up  of 
a  reserve  against  good  will — ^in  reality,  in 
the  pockets  of  the  promoters.  Then  the 
mvestors'  money  is  returned  to  them  and 
the  promoters  become  the  owners.  This 
process  is  fair  only  where  an  equitable  dis- 
tribution has  been  made  between  promoters 
and  investors,  of  common  stock,  or  where 
the  investors  are  themselves  the  promoters, 
and  do  not  dispose  of  their  preferred  stock 
to  the  public. 

Reserves  established  to  provide  for  a 
known  future  demand  are  imperative  if 
we  are  to  have  frequent  showings  of  the 
condition  of  the  business.  Taxes,  interest, 
water  rates — anything  constantly  accruing 


96     Accounting  for  the  Business  Man 

but  payable  at  the  end  of  a  period — come 
within  this  class. 

Reserves  for  depreciation  of  values  are 
the  most  difficult,  particularly  on  accounts 
covering  a  variety  of  items,  because  of  the 
difference  of  normal  expectation  of  life 
usefulness,  and  parity  with  modern  devices. 
To  this  difficulty  a  very  great  element  of 
complexity  and  uncertainty  is  frequently 
added  by  the  possibility  of  unexpected  de- 
velopments in  the  art,  as  we  have  already 
seen.  A  thing  is  worth  only  its  relative 
productiveness.  Souvenirs  have  no  place  in 
accurate  accounting.  Where  it  is  desirable 
to  follow  this  question  closely,  the  items  of 
the  account  should  be  hsted,  described, 
dated,  etc.,  in  the  left  margin  of  a  book 
provided  with  many  columns;  let  each 
column  represent  a  year  or  other  period; 
fix  the  percentage — a  graduated  one,  if  de- 
sired— of  depreciation  of  each  item  or  group 
of  items;  apply  the  ratio  and  enter  the  re- 
sult in  the  year-column;  total  the  column, 
and  divide  the  total  by  the  number  of 
periods  at  which,  during  the  column  period, 
H  is  purposed  to  approximate  a  balance 


Valuation  and  Reserves  97 

sheet.  The  result  will  be  the  amount  of  the 
entry  between  reserve  and  expense  above 
described. 

The  discussion  of  the  macliinery  of  re- 
serves need  not  be  prolonged,  particularly  in 
view  of  the  explanation  of  its  purpose  which 
was  necessarily  involved  in  the  discussion  of 
account  characteristics.  Further  mention 
of  what  becomes  of  these  amounts  in  the 
treatment  of  expenses  will  occur  in  the  dis- 
cussion of  the  expense  and  revenue  ledger, 
and  of  department  costs. 

It  may  be  well  to  carry  the  matter  of 
reserves  for  future  known  demands  a  httle 
farther,  and  also  to  show  how  reserves  which 
have  exceeded  proper  limits  may  be  re- 
turned either  suddenly  or  gradually  to  sur- 
plus account. 

In  relation  to  the  former,  it  is  only  neces- 
sary to  call  attention  to  the  fact  that,  in 
a  very  real  sense,  they  are  more  truly  liabil- 
ities than  other  reserves.  They  are  created 
to  show  the  accruing  amounts  owing  but 
not  yet  due  the  municipality  for  taxes,  the 
water  company  for  water  used,  and  the 
banks  and  note  and  bond  holders  for  inter- 


98     Accounting  for  the  Business  Man 

est.  The  accounts,  instead  of  being  called 
reserves,  might  as  well  be  called  by  the 
names  of  these  respective  interests.  They 
would  then  appear  exactly  like  any  other 
account  on  which  we  record  the  going  out 
of  portions  of  our  good  name  or  credit, 
for  the  payment  of  expenses  incident  to 
running  the  business.  When  we  pay  any 
other  account  owing  on  our  books,  we 
credit  cash  and  charge  that  account;  just 
so  with  these  reserve  accounts.  When  we 
pay  our  taxes  we  credit  cash  and  charge 
the  amount  to  the  appropriate  reserve 
liabihty  account.  If  we  find  that  we  have 
over-estimated  any  such  liability,  and  have 
estabhshed  too  large  a  reserve  against  it, 
two  courses  are  open,  either  to  make  an 
entry  of  the  whole  amount,  debiting  the 
reserve  and  crediting  something  (expense,  if 
the  period  be  not  closed,  otherwise  loss  and 
gain  of  previous  period)  ;or  letting  the  over- 
charge stand,  reduce  the  periodical  entry 
by  enough  to  bring  the  result  to  agree  with 
fact  at  the  termination  of  the  next  period. 
The  former  course  is  the  more  scientifically 
correct,  because  it  brings  the  balance  sheet 


Valuation  and  Reserves  99 

showing  of  the  period  into  hannony  with 
the  truth.  The  latter  course  may  some- 
times be  found  expedient.  This  method 
may  be  used  in  connection  with  any  reserve 
which  it  may  seem  advisable  to  reduce. 
Great  care  must  be  exercised  on  this  point 
in  the  audit,  because  of  the  ease  with  which 
the  net  revenue  of  a  period  can  thus  be 
inflated.  A  method  of  watching  this  will 
be  outlined  in  the  chapter  on  the  relations 
of  the  accounting  system  to  the  duties  of 
the  board  of  directors. 

Entries  of  an  exactly  similar  nature  to 
those  which  create  reserves  are  made  for 
the  purpose  of  reducing  supply  inventory 
accounts  by  the  amounts  consumed  for  the 
period.  For  example,  the  price  of  coal 
being  low,  we  purchase  six  months'  supply, 
store  it,  and  either  pay  money  or  our  good 
name  for  it.  Obviously,  the  credit  side  of 
the  entry  is  cash  or  an  account  payable. 
The  purchase  is  for  expense  account,  but 
not  for  the  expense  of  a  single  month.  If 
we  are  creating  monthly  approximated  bal- 
ance sheets,  we  do  not  want  this  whole  item 
to  appear  as  having  been  consumed  in  one 


100  Accounting  for  the  Business  Man 

month.  We  therefore  make  an  inventory 
account  of  it,  and  then,  at  the  end  of  each 
month  we  credit  this  inventory  account  and 
charge  expense  account.  Frequently  there 
are  several  items  which  should  be  treated  in 
this  manner,  as  gold  and  silver  in  plating, 
powder  in  mining,  and  elaborate  outlay  for 
stationery  and  accounting  system  supplies 
in  banking,  etc.  It  is  not  urged  here,  that 
any  item  should  be  so  handled.  The  rea- 
sons pro  and  con  are  usually  peculiar  to  the 
institution  in  question. 

In  conclusion,  the  whole  subject  of  re- 
serves should  be  thoroughly  understood  by 
every  interest,  or  by  none.  It  is  an  organ- 
ism too  easy  of  impregnation  to  be  exclu- 
sively under  the  influence  of  any  one  indi- 
vidual or  interest. 


CHAPTER  VIII 

INVENTORY  LEDGER:   EXPENSE  AND 
REVENUE  LEDGER 

THE  transition  from  the  consideration 
of  personal  to  impersonal  ledger  ac- 
counts is  made  easy,  by  the  study  of  the 
subjects  touched  upon  in  the  last  two 
chapters,  namely,  intrinsic  peculiarities  of 
the  various  classes  of  accounts,  and  the  ma- 
chinery by  which  their  values  are  main- 
tained at  the  discretion  of  the  proper  au- 
thority. Enough  has  been  said,  for  the 
present,  about  those  accounts  which  repre- 
sent something  owned  or  owed,  i.e.,  asset 
and  liability  accounts,  generally,  aside  from 
the  fact  that  we  have  not  mentioned  the  use 
of  a  separate  ledger  for  inventories. 

This  device  is  employed,  frequently, 
where  the  entries  to  inventories  are  large 
in  number,  and  where  the  consumption  of 
goods,  materials,  or  other  valuable  things 
can  be  concurrently  recorded  in  terms  of 

101 


td^*  Aeeouritang  for  the  Business  Man 

cost.  The  process  consists  merely  in  open- 
ing a  separate  ledger  for  the  purpose,  with 
necessary  columns  in  the  books  of  original 
entry  and  a  governing  account,  or  classified 
governing  accounts  in  the  asset  and  Uability 
ledger.  The  first  entry  in  each  account  is 
the  inventory  at  the  time  of  opening  the 
book.  Then  follow  charges  from  original 
entries  for  purchases  and  credits  for  con- 
sumption. These  credits  come  from  one  of 
three  sources,  as  has  already  been  stated, 
the  contemporaneous  records  of  a  strict 
warehousing  system,  the  material  costs  of 
goods  sold  as  shown  by  a  complete  cost 
system,  or  from  ratios  derived  by  inspection 
of  the  average  percentage  of  gross  profit  on 
goods  sold  and  of  the  ratio  between  the  two 
elements  of  prime  cost,  labour  and  material. 
These  ratios  can  be  corrected  by  inventory, 
and  can  be  made  surprisingly  accurate  with 
the  lapse  of  a  little  time.  This  system  is 
particularly  adaptable  to  an  old  factory, 
where  changes  are  necessarily  slow  and 
expensive,  and  frequently  unpopular.  The 
purpose  of  these  attempts  to  carry  current 
ledger  accounts  with  inventories  is  twofold; 


Inventory  Ledger  108 

it  helps  to  check  extravagance,  carelessness, 
and  loss  from  other  causes,  in  buying,  hand- 
ling, and  carrying  materials  and  supplies 
and  at  the  same  time  it  helps  to  perfect  a 
cost  system  and  create  a  check  thereon.  In 
other  words,  an  ideal  cost  system  would 
not  only  give  the  prime  cost  of  each  article, 
but  it  would  also  show  the  total  value  of 
all  of  these  articles  in  their  two  elements, 
labour  and  material,  which  should  parallel 
the  record  of  the  inventory  ledger  accounts, 
taking  into  account  the  margin  between  lost 
or  ruined  goods  and  scrap  values.  It  is  a 
fact  not  to  be  gainsaid  or  overlooked  that 
such  records,  as  part  of  a  well-organised  ac- 
counting system,  are  worth  many  times  what 
they  cost  to  create  and  maintain.  Indeed, 
the  expense  of  maintaining  several  hundred 
inventory  accounts  is  not  greatly  in  excess 
of  maintaining  five  or  ten,  and  the  results 
obtainable  are  inestimably  more  valuable, 
entirely  aside  from  the  fact  that  this  is  one 
of  the  perfections  of  scientific  operation 
certain  to  lead  to  many  improvements  in 
other  quarters.  It  is  one  of  those  systems 
which  do  the  work  scientifically  and  in  ad- 


104s  Accounting  for  the  Business  Man 

vance  rather  than  loosely,  and  in  arrearages, 
like  the  ordinary  inventory  and  cost  sys- 
tems; and  it  has  the  great  advantage  of 
making  frequent  balance  sheets  possible. 
This  contemporaneousness  of  accounting 
results  is  highly  desirable.  If  we  are  losing 
money,  or  making  too  little,  let  us  know  it 
at  the  end  of  one  month  rather  than  at  the 
end  of  fourteen,  when  we  shall  be  well  into 
the  second  year  on  the  same  basis.  (We 
allow  the  two  extra  months  for  the  com- 
pilation and  calculation  of  the  old-fashioned 
inventory.)  An  enthusiastic  advocate  of 
modern  methods  used  the  argument  that  if 
the  workmen  in  the  factory  were  engaged 
in  polishing  coins,  even  were  they  but  pen- 
nies, a  careful  account  would  be  carried 
with  each  workman.  Why  not,  therefore, 
record  materials,  some  of  which  are  just 
as  valuable? 

From  the  inventory  ledger  we  come  by 
an  easy  stage  to  another  ledger  which  deals 
with  the  question  of  costs  also,  both  of  the 
business  as  a  whole  and  by  departments;  at 
the  same  time  greatly  facilitating  the  proper 
handling  of  detail  costs.  This  is  the  ledger 


Inventory  Ledger  105 

whose  twofold  purpose  is  to  classify  and 
analyse  the  expenses  of  conducting  the 
business,  and  to  divide  them  among  the 
departments  or  stages  of  operation.  For 
convenience  in  grouping  and  handling,  ac- 
counts may  also  be  opened  in  this  ledger 
for  the  various  forms  of  revenue.  This 
ledger  may  reasonably  be  called  an  expense 
and  revenue  ledger.* 

We  have  seen  that  the  books  of  original 
entry  may  be  so  arranged  that  those  entries 
or  parts  of  entries  which  belong  to  any  par- 
ticular ledger,  whether  it  be  a  record  of 
detail  accounts  or  the  real  and  final  ledger, 
may  be  grouped  in  columns  which  exclude 
everything  else,  and  that  this  arrangement 
of    columns    is    highly    elastic.      In    other 

•Much  confusion  arises  in  understanding  accounting 
through  the  use  of  stereotyped  and  often  meaningless 
names.  Books,  accounts,  and  statements  should  be  called  by 
names  that  are  descriptive  of  their  functions.  Ledger  is 
the  only  word  in  the  whole  nomenclature  of  accounting  that 
has  come  to  have  a  fixed  and  invariable  significance,  and  it 
would  be  well,  with  the  development  of  the  science,  if  that 
name  could  be  confined  to  the  governing  or  final  ledger 
from  which  the  epitomised  balance  sheet  must  be  drawn. 
The  intermediate  ledgers  could  be  called  payable  account 
record,  receivable  account  record,  inventory  account  rec- 
ord, expense  and  revenue  account  record,  etc. 


106  Accounting  for  the  Business  Man 

words,  one  debit  column  and  one  credit 
column  in  each  book  of  original  entry  would 
be  adequate,  if  we  were  willing  to  recapitu- 
late sufficiently  to  secure  the  totals  from 
which  to  create  the  governing  accounts,  and 
also  if  we  were  willing  to  lose  the  advan- 
tage of  certain  special  account  columns  by 
whose  operation  a  single  posting  suffices  for 
the  month  to  the  most  active  accounts,  such 
as  cash  discount,  both  on  purchases  and 
sales.  This  arrangement  of  books  of  origi- 
nal entry  is  to  be  determined  purely  as  a 
matter  of  convenience.  There  are  no  scien- 
tific laws  governing  it,  beyond  the  cardinal 
principle. 

With  this  idea  of  the  sources  in  mind,  we 
are  ready  to  proceed  to  the  accounts  in  the 
expense  and  revenue  ledger. 

The  revenue  accounts  consist  of  three 
classes:  Direct  revenue,  or  that  obtained 
directly  from  the  main  operation  of  the 
business;  administration  revenue,  those 
which  come  from  the  exercise  of  good 
abilities  in  the  organisation,  as  especial 
rebates  on  purchases,  cash  discounts  ob- 
tained by  clever  financing,  etc.    There  are 


Inventory  Ledger  107 

revenues  from  these  sources  in  the  most 
stupidly  run  business,  and  it  is  impossible 
to  differentiate;  therefore  all  such  revenues 
may  be  called  administrative,  with  the  view 
of  encouraging  the  management  to  further 
activity;  then,  there  are  incidental  revenues, 
most  of  which  do  not  strictly  belong  to  the 
operations  of  the  period,  as  the  receipt  of 
money  from  an  account  long  ago  wiped  out 
as  valueless,  the  sale  of  some  article  or 
stock  supposed  to  be  unsalable,  and  whose 
value  has  been  removed  from  profits  of  a 
previous  year  by  exclusion  from  the  in- 
ventory of  that  period,  the  margin  over 
normal  price  received  for  land  or  other  pos- 
session rendered  unexpectedly  valuable  to 
some  one  else  by  circumstances  over  which 
the  management  has  no  control.  Indeed,  a 
list  of  possible  incidental  revenues  could  be 
indefinitely  extended,  and  there  is  no  field 
in  which  they  do  not  occur.  They  are  least 
frequent  in  a  carefully  run  enterprise  which 
has  been  properly  accounted  upon  during 
its  whole  existence,  and  whose  subject  of 
trade  is  a  staple  of  common  use.  In  min- 
ing such  profits  are  so  much  to  be  looked 


108  Accounting  for  the  Business  Man 

for  that  promoters  commonly  capitalise 
their  expectations  in  addition  to  known 
values. 

It  is  fully  as  important  to  analyse  reve- 
nues as  expense  because  the  policy  for  the 
future  must  be  framed  without  undue  con- 
sideration of  what  we  have  termed  inci- 
dental revenue.  Even  direct  revenue  may 
be  abnormally  inflated  by  evanescent  con- 
ditions, as  in  the  case  of  a  railroad,  by  the 
transportation  of  the  product  of  some  tem- 
porary activity  or  in  manufacture,  by  get- 
ting into  some  line  ahead  of  all  competitors, 
and  thus  being  enabled  to  hold  prices  at  a 
high  level  for  a  time;  in  financial  business 
there  are  periods  of  abnormal  activity;  and 
in  mining,  the  grade  of  the  ore  may  chance 
to  run  high  for  a  certain  period  in  all  the 
workings.  Hence,  even  direct  revenues  re- 
quire careful  analysis  in  the  light  of  all 
obtainable  information,  if  we  are  not  to  be 
misled. 

It  is  advisable  to  credit  all  incidental 
revenues  directly  to  the  account  in  the 
final  or  governing  ledger  which  we  have 
cafled  loss  and  gain  of  previous  period.    If 


Inventory  Ledger  109 

this  course  be  deemed  too  strenuous,  let  an 
account  be  opened  on  the  first  page  of  the 
expense  and  revenue  ledger,  and  let  these 
items  be  credited  to  it,  with  clear  refer- 
ence to  documents  which  shall  fully  describe 
the  transaction.  A  careful  analysis  of  this 
account  should  be  one  of  the  duties  of  the 
auditing  committee  of  the  board  of  direct- 
ors, particularly  if  there  be  contracts  call* 
ing  f or  a  division  of  profits  with  managers, 
employees,  or  others. 

The  next  page  should  be  given  to  ad- 
ministration revenue,  because,  in  grouping 
the  expense  accounts,  it  is  the  most  natural 
course  to  place  the  administrative  group 
first.  This  brings  the  two  together  in  the 
monthly  chart  of  accounts,  which  renders 
easy  their  comparison,  both  by  totals  and  by 
ratios  of  progress.  It  is  well  to  itemise 
administrative  revenue  entries  briefly  in  the 
ledger  for  purposes  of  analysis.  They  may 
be  carried  in  a  group  of  accounts,  rather 
than  in  a  single  one,  at  least  during  a  period 
of  close  analysis  and  watching  of  the  busi- 
ness. 

The  main  source  of  revenue  goes  either 


110  Accounting  fur  the  Business  Man 

with  the  selling  expense  group  or  with  the 
operating  expense  group,  and  is  capable 
usually  of  division  into  as  many  accounts  as 
there  may  be  subdivisions  of  the  group 
with  which  they  occur.  In  the  food  busi- 
ness, for  example,  and  merchandising  and 
manufacture,  where  the  selKng  functions  of 
the  business  are  all-important,  the  revenue 
is  more  closely  connected  with  those  func- 
tions; while  in  other  forms  of  manufacture, 
in  railroading,  mining,  etc.,  the  selling  group 
becomes  comparatively  unimportant,  and  it 
is  the  operating  group  that  has  most  to 
do  with  the  volume  of  these  revenues,  as 
well  as  with  the  economies  affecting  the  net 
revenue. 

The  simplest  form  of  this  account  exists 
where  the  thing  sold  is  an  idea,  or  other 
unmaterial  thing  whose  prime  cost  involves 
no  outlay  for  material,  as  the  sale  of  expert 
services  of  lawyers,  doctors,  mining  engi- 
neers, accountants,  and  other  professional 
men.  It  is  also  very  simple  where  the  cost 
of  material  can  be  segregated  in  posting  the 
sales  from  the  original  entry  record,  so  that 
that  item  can  be  credited  directly  to  inven- 


Inventory  Ledger  111 

tones,  and  the  margin  of  sales  price  over 
material  cost  carried  to  this  accomit.  In 
these  cases  the  amount  of  this  account 
represents  what  is  usually  termed  gross  in- 
come plus  operating  and  selling  expense. 

Where  this  segregation  of  sales  volume 
into  the  two  elements  of  material  cost  and 
margin  cannot  be  readily  effected,  it  becomes 
necessary  to  treat  the  whole  volume  of  sales 
as  a  revenue.  It  is  at  this  point  that  the 
difficulty  arises  in  making  frequent  balance 
sheets.  The  only  exact  method  of  arriving 
at  the  cost  of  material  included  in  this  item 
is  to  inventory  the  material  left  on  hand, 
and  subtract  that  from  the  inventory  at  the 
beginning  of  the  period,  plus  purchases  dur- 
ing the  period.  This  becomes  easy  if  we 
have  in  operation  an  inventory  ledger,  as 
described  in  this  chapter,  backed  up  and 
made  possible  by  a  thorough  warehousing 
system.  The  absence  of  cost  records  and 
inventory  accounts  should  not  discourage  an 
attempt  to  approximate  the  result. 

Frequently  a  careful  analysis  will  dis- 
close an  average  margin  of  gross  profit  in 
the  sales,  i.e.,  a  percentage  by  which  selling 


112  Accounting  for  the  Business  Man 

price  exceeds  prime  cost.  The  application 
of  this  ratio  to  volume  of  sales  gives  us  a 
quantity  made  up  of  two  elements,  direct 
labour  and  material  consumed.  Further 
analysis  will  frequently  disclose  the  ratio 
between  these  two.  (In  this  work  the  serv- 
ices of  men  accustomed  to  the  calculation  of 
estimated  costs  in  the  business  in  question 
are  often  available.)  This  double  operation 
produces  an  estimated  valuation  of  the  ma- 
terial cost  of  goods  sold.  Where  the  former 
of  the  two  ratios  cannot  be  reached,  the 
appUcation  of  the  latter  to  the  direct  labour 
recorded  by  departments  or  otherwise  for 
the  period,  will  give  an  estimated  valua- 
tion of  the  material  cost  of  goods  manu- 
factured, the  use  of  which  is  always  con- 
servative so  long  as  the  sales  do  not  deplete 
the  stock  of  raw  materials  or  manufactured 
goods  on  hand  at  the  beginning  of  the 
period.  In  the  case  of  such  depletion  it  is 
not  difficult  to  arrive  at  a  margin  of  safety. 
Having  approximated  the  volume  of  ma- 
terial cost  in  the  total  sales  figure,  we  can 
easily  offset  that  much  of  this  revenue 
account  by  opening  among  the  operating 


Inventory  Ledger  113 

expenses  an  account  called  material  con- 
sumed. We  debit  this  account  with  the 
whole  amount  of  the  estimate,  crediting 
inventory  accounts.  This  operation  reduces 
inventory  plus  purchases,  by  the  amount 
of  estimated  consumption,  and  produces  an 
account  balance  which  approximates  the 
present  inventory.  Its  correctness  can  only 
be  determined  by  taking  an  actual  physical 
inventory.  The  old-fashioned,  arduous  an- 
nual inventory  automatically  provides  a 
check  upon  the  accuracy  of  this  calculation, 
but  there  is  no  better  means  of  bringing 
a  force  to  the  realisation  of  the  possibilities 
and  advantages  of  a  warehousing  system 
than  by  calling  for  a  new  inventory  every 
month  or  two,  after  this  system  is  put  into 
operation.  It  can  be  explained  that  the 
work  need  not  be  quite  so  conscientiously 
done,  and  that  some  extra  clerks  at  small 
salaries  can  be  provided.  The  result  will 
invariably  be  an  attempt  on  the  part  of  the 
more  intelligent  among  the  employees  re- 
sponsible for  the  stock  to  create  and  main- 
tain a  record  of  what  goes  out  and  comes 
in  for  their  own  protection.    It  will  be  soon 


114  Accounting  for  the  Business  Man 

apparent  that  this  record  spreads  the  in- 
ventory process  throughout  the  year,  keeps 
the  stock  in  better  physical  and  working 
condition  and  stops  losses  from  various 
causes.  Each  department  will  soon  be 
found  calling  for  a  locked  wareroom  with 
a  regular  system  for  recording  the  issue  and 
receipt  of  material.  The  complete  annual 
inventory  can  safely  be  dispensed  with  if  a 
competent  inventory  auditor  be  employed, 
whose  duty  it  shall  be  to  go  from  one  de- 
partment wareroom  to  another,  checking 
the  contents  of  the  receptacles  with  the 
wareroom  record  and  the  corresponding  ac- 
count in  the  inventory  ledger. 

With  the  perfection  of  this  system  comes 
the  frequent  actual  balance  sheet.  Its  fre- 
quency is  only  measured  by  the  periods  of 
summarising  the  books  of  original  entry 
and  of  calculating  reserve  and  depreciation 
entries.  But  even  without  the  warehousing 
system  we  can  continue,  year  by  year,  cor- 
recting our  ratios  in  the  light  of  experience, 
until  eventually  they  become  so  close  a 
check  upon  the  physical  inventory  as  to 
drive  the  stockman  to  the  use  of  records 


Inventory  Ledger  115 

and  other  precautions  for  his  own  defence, 
and  the  end  of  that  also  is  a  proper  and 
complete  record.  The  accountant  who  thor- 
oughly understands  his  weapons  needs 
only  patience  to  bring  the  most  obstinate 
forces  into  conformity  with  constantly  im- 
proving methods. 

This  brings  us  to  the  consideration  of 
the  items  which  must  be  subtracted  from 
the  whole  volume  of  revenue  in  the  course 
of  the  process  of  reducing  it  to  terms  of 
net  profit.  They  are  expenses,  and  in  their 
treatment  we  shall  reverse  the  order  in 
which  we  have  discussed  revenues.  The 
last  account,  or  group  in  the  ledger,  is  direct 
labour.  The  expenditure  represented  by 
this  account  is  segregated  from  other  labour 
items  in  the  distribution  of  the  pay-roll, 
made  up  from  the  original  records  of  work- 
men's time.  It  covers  the  total  amount 
paid  for  productive  labour,  that  is  labour 
in  the  actual  making  of  the  thing  to  be  sold, 
as  distinguished  from  all  other  work.  This 
sum  is  particularly  the  concern  of  the  de- 
tail cost  system.  An  ideal  cost  system  is 
one  which  shows  for  each  period  the  dis- 


116  Accounting  for  the  Business  Man 

tribution  of  every  cent  of  this  item  over  the 
goods  actually  produced  during  the  period, 
including  the  distribution  of  all  lost  labour 
over  those  articles  which  actually  arrived 
at  salable  condition.  The  proper  field  of 
analysis  of  this  item  is  the  comparison  of 
wages  and  productiveness  of  the  workmen, 
one  with  another,  and  with  their  own  past 
records  as  well  as  with  the  records  of  men  in 
similar  hnes.  Vast  simplification,  and  in- 
creased productiveness,  usually  result  from 
paying  piece  prices.  In  many  lines,  how- 
ever, great  care  must  be  exercised  to  avoid 
losing  in  quality  more  than  is  gained  in 
quantity. 

The  next  group  of  expense  accounts, 
working  backward  through  the  expense  and 
revenue  ledger,  might  be  described  as  the 
general  operating  expenses.  They  cover  all 
expense  aside  from  direct  labour,  selUng 
and  administrative  expense — ^power,  tool 
making,  repairing,  factory  supplies,  and 
many  others.  They  may  be  divided  into  an 
indefinite  number  of  accounts,  if  it  seems 
desirable  to  analyse  them  in  great  detail. 
There  is  not  much  to  be  said  about  them, 


Inventory  Ledger  117 

from  the  auditing  standpoint,  without  say- 
ing more  than  there  is  space  for.  Each 
one  should  be  watched  closely  and  its 
meaning  studied.  These  items  come  from 
the  purchase  record,  the  pay-roll  distribu- 
tion and  the  adjusting  entries,  where  items 
of  depreciation  are  charged,  in  the  process 
of  establishing  reserves.  Items  come  also 
from  the  petty  cashbook  and  from  the 
record  of  cash  paid  out,  and  may,  under 
certain  circumstances,  come  from  other 
sources. 

The  next  group  is  selling  expense,  which 
covers  salaries  and  travelling  expenses,  ad- 
vertising, catalogues,  etc.,  and  the  first 
group  is  the  administrative  expense,  which 
covers  officers'  salaries,  interest,  etc.  Both 
of  these  groupings  are  largely  discretion- 
ary. One  of  the  main  considerations  re- 
garding them  will  be  more  clear  when  we 
come  to  discuss  their  distribution  over  de- 
partments by  means  of  formulae. 

The  expense  and  revenue  ledger,  if  it 
include  a  system  for  recording  the  consump- 
tion of  material,  affords  the  same  key  to 
the    situation   that    the    balance    sheet    or 


118  Accpunting  for  the  Business  Man 

governing  ledger  does,  but  in  terms  of 
revenue  and  expense  rather  than  in  ratio  of 
assets  to  liabihties.  It  is  a  paying  plan  to 
have  it  operated  by  a  man  of  considerable 
practical  experience  in  the  business,  because 
of  the  opportunities  for  economies  which  it 
suggests  to  such  a  man. 

With  very  little  additional  work  the 
ledger  can  be  made  the  means  of  getting 
department  costs,  and  percentages  for  addi- 
tion to  prime  cost  by  departments,  thus 
solving  one  of  the  most  vexing  of  all  ac- 
counting problems,  namely  the  determina- 
tion, in  a  complicated  business,  of  the 
relative  results  of  the  various  output  de- 
partments. It  can  be  made  to  show 
whether  it  pays  to  make  or  carry  certain 
lines.  The  ensuing  chapter  will  be  devoted 
to  an  explanation  of  how  this  is  done. 


CHAPTER  IX 

DEPARTMENT     COSTS     AND     CONTINGENT 
ADDITION 

ONE  method  of  arriving  at  a  distribu- 
tion of  expenses  by  departments  is  to 
apportion  them  at  the  end  of  the  period, 
usually  by  an  exceedingly  rough  estimate, 
or  according  to  volume  of  sales.  Obviously 
neither  method  is  scientific,  and  the  latter 
is  especially  open  to  objection  because 
that  department  which  shows  the  smallest 
volume  of  sales  may  possibly  require  the 
greatest  amount  of  attention  in  some  par- 
ticular, or  may  have  the  heaviest  investment 
in  plant,  as  in  the  case  of  a  line  of  goods 
which  has  been  stifled  by  competition. 

Another  method  is  to  open  for  each  de- 
partment a  few  expense  accounts  into 
which  everything  goes;  and  the  benefit  of 
close  analysis  of  expenses  is  entirely  lost. 

Altogether  the  best  method  is  to  add  to 

119 


120  Accounting  for  the  Business  Man 

each  page  of  the  expense  and  revenue 
ledger  a  column  for  each  department,  i.e., 
output  department,  or  for  each  stage  of 
manufacture,  where  the  hne  produced,  or 
sold,  is  homogenous.  This  plan  is  appli- 
cable to  any  line  of  business,  from  broker- 
age to  farming.  The  original  entries  are 
made  exactly  as  for  the  expense  and  revenue 
ledger,  as  explained  in  the  last  chapter,  but 
with  the  addition,  in  the  "  particulars " 
column  of  a  letter,  member,  or  hieroglyphic 
to  indicate  which  department  or  which  de- 
partments are  concerned  with  the  charge. 
This  mark  can  be  made  on  the  bill,  check 
record,  or  petty  cash  voucher,  by  the  man 
who  indicates  the  account,  and  at  the  same 
time;  and  there  are  conditions  under  which 
he  might  make  his  posting  at  the  same  time 
to  the  proper  expense  account,  relying  upon 
the  governing  account  to  act  as  a  check 
upon  its  accuracy.  Another  simplification 
might,  in  some  instances,  be  achieved  by 
cards  made  at  this  stage  and  dropped  into 
receptacles  arranged  by  accoimt  and  de- 
partment, to  be  totalled  later.  This  plan 
i$  not  recommended  for  general  use. 


Department  Costs  121 

Several  objections  may  be  urged  by  ac- 
countants who  have  never  seen  this  system 
in  operation.  It  is  indeed  an  innovation  to 
add  to  a  ledger  page  columns  for  further 
distribution  of  posted  items.  It  is  a  little 
like  resurrecting  the  dead  and  buried.  The 
further  development  of  the  science  of  ac- 
counting will  come  mainly  through  the 
establishment  of  psychic  communication 
with  these  hitherto  lost  ones.  It  is  not  im- 
probable that  the  asset  and  liability  ledger, 
itself,  may  give  forth  tones,  under  the  in- 
fluence of  proper  mediums.  In  other 
words,  the  creation  of  new  forms  for  keep- 
ing in  active  communication  with  balance 
sheet  accounts  is  conceivable,  and  it  will  be 
coupled  with  the  operations  of  valuations 
and  reserves. 

This  expense  and  revenue  ledger  page, 
from  left  to  right,  is  arranged  as  follows: 
explanation  and  item,  date,  source,  depart- 
ment mark,  debit  column,  credit  column, 
as  many  columns  as  there  are  stages,  de- 
partments, mills,  shafts,  or  other  divisions 
in  the  strict  classification  determined  upon. 
The  mingling  of  two  or  more  classifications 


122  Accounting  for  the  Business  Man 

must  be  avoided.  If  output  departments 
are  decided  upon,  operating  departments 
must  not  be  included.  These  latter  are  to 
be  distributed  over  the  former.  Otherwise 
logical  procedure  is  impossible,  and  the 
results  become  chaotic.  It  is  never  desir- 
able to  compare  unlike  elements  at  this 
stage. 

The  number  of  items  which  will  be  dis- 
tributable by  their  intrinsic  character,  in- 
creases with  each  group,  until  we  reach  the 
last,  which  is  direct  labour,  all  of  which 
distributes  itself  in  making  the  pay-roll 
distribution.  Naturally  material  consumed, 
if  we  are  fortunate  enough  to  have  it,  also 
distributes  itself. 

Administrative  expense  is  difficult  to  dis- 
tribute, but  the  president's  salary,  taken  as 
an  item  by  itself,  is  not  so  difficult  to 
distribute  as  would  be  the  whole  lump  sum 
of  all  general  expenses.  The  same  reason- 
ing applies  to  each  separate  item,  and  even 
were  the  difficulty  greater,  the  object  war- 
rants the  effort.  Each  locomotive  built 
and  sold,  each  block  of  bonds  sold,  each 
shaft  and  ore  body  developed,  each  mile  or 


Department  Costs  128 

section  of  railroad  built  or  operated,  each 
quart  of  milk  produced,  costs  some  por- 
tion of  the  president's  salary;  the  percent- 
age of  his  salary  which  it  costs  may  not 
be  the  same  as  the  percentage  of  oil  and 
waste,  or  of  printing  of  prospectuses,  or 
of  mule  hire,  or  of  haulage,  or  of  fertil- 
iser. Very  seldom  is  the  president's  salary, 
or  any  other  general  item,  fairly  distrib- 
utable according  to  sales.  His  time  may 
be  largely  taken  up  for  a  long  period  in 
the  development  of  a  new  department. 
Formulae  can  be  devised  for  the  dis- 
tribution of  single  items.  Often  it  will 
be  found  that  the  whole  group  of  adminis- 
trative expenses  can  be  distributed  by  one 
formula  which  takes  into  account  volume  of 
investment,  space,  output,  and  certain  espe- 
cial considerations.  The  sales  group  em- 
braces some  self-distributable  items,  as 
department  catalogues  and  advertising, 
especial  salesmen,  or  especial  trips.  The 
others  are  distributable  according  to  vari- 
ous considerations,  most  of  which  readily 
suggest  themselves,  as  relative  amount  of 
time  spent  by  a  salesman  on  various  lines. 


124  Accounting  for  the  Business  Man 

Factory  general  expenses  are  more 
largely  self-distributable,  and  the  others 
generally  suggest  their  own  formulae,  as 
power,  sweeping  and  cleaning,  etc.,  etc.  In 
this  group,  where  output  departments  are 
segregated,  operation  sub-departments,  do- 
ing work  for  two  or  more  main  depart- 
ments, must  be  distributed,  often,  in  total, 
according  to  the  volume  done  of  each  main 
department's  work.  Sometimes  only  a  rough 
distribution  can  be  effected,  but  it  is  better 
than  none,  and  is  not  likely  to  correspond 
to  the  distribution  of  the  president's  salary, 
hence  better  even  to  guess  at  it  separately. 
One  may  entirely  leave  out  certain  depart- 
ments for  which  it  does  no  work;  the  other 
works  for  all,  or  should,  at  least. 

It  is  well  to  provide  a  page  at  the  end 
of  each  group  for  totalling  the  columns. 
Those  groups  whose  accounts  are  distrib- 
utable by  a  single  formula  may  be  totalled 
and  brought  forward  to  this  page  before 
the  apphcation  of  the  formula.  It  will  be 
found  that  the  time  required  for  this  dis- 
tribution once  a  month  is  surprisingly 
short,   and  the  work  can  be  done  by   a 


Department  Costs  125 

clever  stenographer,  the  formula  being 
established.  In  a  large  business  the 
formulae  should  be  scrutinised  by  the 
auditing  committee  of  the  board  of  di- 
rectors, in  order  to  make  sure  that  injustice 
be  done  no  department. 

The  expenses  being  thus  redistributed 
according  to  groups  and  departments,  the 
next  step  is  to  open  an  account  in  the  gov- 
erning ledger  for  each  department,  calling 
it  "  results  of  department  A,  B,  or  C." 

Open  the  expense  and  revenue  ledger  at 
the  page  on  which  appears  the  distributed 
total  of  administrative  expense.  From 
this  page  post  the  total  administrative  ex- 
pense to  the  credit  side  of  the  governing 
account  of  this  ledger,  in  the  governing 
ledger,  and  the  several  department  amounts 
to  the  proper  results  accounts.  Continue 
similarly  with  the  other  groups.  The  reve- 
nues, having  been  also  distributed,  may  be 
posted  to  governing  and  results  accounts. 

This  operation  will  wipe  out  the  govern- 
ing account  and  establish  in  its  stead  a 
results  account  for  each  department,  whose 
balance  will  be  the  profit  or  loss  on  that 


126  Accounting  for  the  Business  Man 

department  for  the  period,  whose  first  three 
charges  will  be  the  source  of  the  con- 
tingent addition  for  that  department,  if 
carefully  analysed  for  a  sufficient  period, 
and  whose  fourth  and  fifth  charges  will 
be  the  items  whose  volume  should  be  ac- 
counted for  by  the  detail  cost  department 
for  the  period,  if  that  department  is  to 
justify  its  work  by  proving  its  accuracy. 
The  account  will  appear  as  follows: 

RESULTS  OF  DEPARTMENT  A. 

Administrative  expense  Administration  revenue 

Selling  expense  Main  revenue 

Factory   general  expense 
Direct  labor 
Material    consumed 


Balance  Profit  or    Balance  Loss 

If  main  revenue  be  reduced  to  margin  in 
sales  over  material  cost,  the  last  debit  item 
will  not  appear,  and  the  cost  system  will 
look  to  the  inventory  ledger  for  figures 
against  which  to  check  its  reckoning  of 
material. 

It  is  at  this  point  that  the  connection  is 
closest  between  general  accounting,  and  de- 
tail costs,   and  it  is  seldom  advisable  to 


Department  Costs  127 

undertake  the  establishment  of  a  current 
cost  recording  system  without  first  carrying 
the  general  accounts  to  this  point.  It  is 
never  wise  for  any  one  incapable  of  carry- 
ing the  general  accounts  to  this  point  to 
endeavour  to  create  a  current  cost  recording 
system,  because  of  almost  inevitable  er- 
roneous inclusion  and  exclusion;  because  of 
the  impossibility  of  consistently  develop- 
ing items  on  the  border  line  between  direct 
and  indirect  labour,  and  because  of  the 
fact  that  prime  costs,  even  if  correctly 
calculated,  have  a  limited  value  without  the 
contingent  addition. 

The  importance  of  correct  department 
contingent  addition  to  prime  cost,  or  better 
yet,  the  knowledge  of  what  volume  of  goods 
must  be  sold  at  market  price  to  cover  the 
general  cost  of  operating  the  department, 
can  be  clearly  seen  if  we  take  into  account 
the  fact  that  it  is  constantly  necessary  to 
make  prices  without  guidance  other  than  a 
knowledge  of  what  we  can  afford  to  accept. 

There  is  one  feature  which  has  been 
omitted  for  fear  of  getting  into  too  great 
technicality.     It  is  the  distinction  between 


128  Accounting  for  the  Business  Man 

items  of  general  expense  according  to  their 
degree  of  variation  with  volume  of  output. 
Generally  it  is  safe  to  proceed  to  the  stage 
above  outlined  without  much  regard  for 
this,  and  when  this  stage  is  reached  it  will 
be  found  that  the  results  accounts  will  be 
suiBciently  illuminating  to  facilitate  the  cal- 
culation of  reductions  of  price  which  may 
be  safely  made  to  insure  larger  volume  or 
meet  competition. 


CHAPTER  X 

FUNDAMENTAL    PRINCIPLES    OF    COST 
ACCOUNTING 

THERE  are  three  entirely  distinct  but 
interdependent  cost  systems  in  oper- 
ation in  every  thoroughly  well-organised 
business.  The  expense  ledger  described  in 
Chapter  VIII  constitutes  the  machinery  of 
the  first  of  these  three  systems.  This  sys- 
tem comes  first  in  point  of  order  chrono- 
logically, because  it  is  the  inevitable  result 
of  double-entry  accounting  to  carry  ledger 
accounts  for  the  expense;  furthermore,  it 
must  come  first  and  be  properly  organised 
if  the  others  are  to  be  created  on  sound 
principles;  in  relative  importance  it  stands 
first,  because  the  others  may  be  approxi- 
mated or  even  dispensed  with  for  a  long 
time;  but  regardless  of  competition  and  all 
other  price-lowering  factors,  a  business 
whose  expense  accounts  are  not  watched  is 

almost  sure  to  suffer  eventually. 

1^ 


130  Accounting  for  the  Business  Man 

The  rearrangement  of  the  expense  ledger 
explained  in  Chapter  IX  provides  the  ma- 
chinery for  the  second  cost  system.  This 
system  follows  naturally  the  proper  organ- 
isation of  the  first  and  can  be  instituted  in 
any  business  at  any  time  by  merely  printing 
ledger  sheets  with  the  department  columns 
and  giving  instructions  to  mark  original 
entries  with  department  signs.  In  relative 
importance  this  system,  even  in  a  business 
whose  output  is  homogeneous,  is  next  to 
the  main-cost  system,  because  it  shows 
where  the  losses  are  and  tells  which  lines 
to  push,  and  because  it  lays  the  founda- 
tion for  the  derivation  of  right  selling 
prices  from  the  figures  of  the  detail-cost 
system,  that  is,  it  furnishes  a  fair  percent- 
age of  contingent  addition  thereto,  and 
shows  clearly  the  volume  of  business  neces- 
sary to  provide  for  the  total  of  that  addi- 
tional or  general  operating  expense. 

The  last  system  to  come  into  existence  as 
a  currently  recording  system  is  the  detail- 
cost  system,  because  it  cannot  be  created  on 
sound  principles  without  the  other  two. 
Cost  systems  are  devised  and  put  in  opera- 


Principles  of  Cost  Accounting     131 

tion  without  regard  to  the  other  two  sys- 
tems, but  their  results  if  good  are  purely 
fortuitously  so;  frequently  they  are  bad; 
generally  the  system  breaks  down  alto- 
gether. This  absence  of  close  connection 
with  the  general  accounting  is  the  cause  of 
the  failure  because,  in  a  business  where  the 
general  accounting  does  not  segregate  those 
items  which  constitute  the  rightful  material 
of  the  detail-cost  system,  arranging  every- 
thing else  for  proper  use  in  its  place,  the 
field  is  so  indefinite  that  the  cost  department 
does  not  know  what  to  include  and  what 
to  omit  in  making  its  calculations ;  and  there 
is  no  mathematical  proof  that  all  omitted 
items  are  included  in  the  calculation  of  the 
percentage  to  be  added  to  prime  cost. 

The  cost  system  must  make  use  of  all 
material  that  belongs  to  it,  including  every 
cent  of  lost  labour  and  material.  It  usu- 
ally happens  that  in  the  process  of  manu- 
facture a  few  articles  or  parts  are  ruined, 
or  the  material,  after  some  work  has  been 
expended  upon  it,  is  discovered  to  be  de- 
fective. The  value  of  the  whole  material 
has  been  included  in  the  credit  entry  on 


132  Accounting  for  the  Business  Man 

inventory  account,  and  the  debit  entry  to 
material  expended  or  consumed  account. 
If  this  neglected  item  be  large,  as  actually 
happens  at  times,  the  balance  sheet  will  show 
a  result  very  different  from  that  promised 
by  the  margin  between  our  defective  cost 
figures  and  selling  price. 

The  same  may  be  said  of  lost  labour. 
The  nature  of  the  product  determines 
whether  these  losses  shall  be  included  in 
prime  cost,  added  to  a  general  expense 
account  for  inclusion  in  the  contingent,  or 
charged  directly  to  losses  for  the  current 
period.  The  stage  through  which  the  busi- 
ness is  passing  has  also  an  important  bear- 
ing. To  take  an  extreme  case  for  illustra- 
tion, suppose  the  product  to  be  flying- 
machines  of  some  type.  This  is  a  large  and 
costly  unit  of  production,  still  in  a  more 
or  less  experimental  stage.  A  macliine  is 
carried  to  the  point  of  making  the  first 
actual  flight  in  the  process  of  testing  before 
finishing.  An  accident,  due  to  a  remediable 
cause,  results  in  complete  demolition.  The 
cost  of  the  lot  of  ten  machines  has  been 
carefully  recorded  contemporaneously  with 


Principles  of  Cost  Accounting     133/ 

their  construction.  We  know  the  exact 
loss:  what  shall  we  do  with  it?  We  do  not 
expect  one  of  every  ten  machines  to  meet 
a  similar  fate,  and  furtheimore  the  com- 
petition is  becoming  every  day  keener  on 
our  particular  type  of  machine.  Therefore 
we  must  keep  our  selling  prices  free  from 
abnormal  elements  of  cost.  There  is  but 
one  thing  to  do.  The  amount  must  come 
out  of  the  anticipated  profits,  and  we  may 
as  well  be  conservative  and  take  it  out  of 
the  present  period.  On  the  other  hand,  the 
accident  may  be  a  blessing  in  disguise, 
for  it  may  result  in  some  discovery  which 
makes  our  system  of  flight  vastly  more 
reliable  than  formerly.  In  this  case,  par- 
ticularly if  the  loss  be  too  heavy  to  be  born 
by  a  single  period  without  serious  setback 
to  our  enterprise,  it  would  not  be  unrea- 
sonable to  charge  the  amount  to  some 
account  which  would  indicate  the  good  re- 
sulting, call  it  experiment  account,  perhaps, 
and  carry  it  among  the  assets  until  it 
should  have  been  wiped  out  by  monthly 
depreciation  charges  so  divided  as  to  spread 
it  over  the  determined  period  of  time.    This, 


134  Accounting  for  the  Business  Man 

like  many  other  things  in  accounting,  is 
subject  to  abuse.  The  other  extreme  is  a 
loss  of  several  out  of  several  thousand  parts, 
worth  only  a  fraction  of  a  cent  in  all,  and 
normally  likely  to  recur  constantly.  These 
losses,  small  in  themselves,  aggregate  large 
sums,  under  certain  conditions,  and  unless 
the  whole  item  of  direct  labour  and  the 
whole  of  material  issued  be  charged  to  the 
number  of  parts  returned,  the  total  charged 
to  costs  will  not  agree  with  the  amount  set 
aside  as  belonging  to  them,  and  therefore 
left  out  of  contingent. 

To  secure  the  nearest  possible  approach 
to  this  mathematical  accuracy  in  cost  ac- 
counting, the  records  must  be  made  not 
weeks  or  months  after  the  expenditure  to 
be  accounted  for,  but  at  the  time.  In 
general  this  is  true  of  all  calculations  which 
must  6t  should  be  compared  in  their  results. 
In  particular  it  is  true  here  because  there 
are  and  will  always  be  many  occasions  for 
conference  between  the  cost  department  and 
the  operating  departments  as  to  the  mean- 
ing and  correctness  of  records.  It  is  un- 
reasonable to  expect  workmen  or  even  fore- 


,  Principles  of  Cost  Accounting     135 

men  to  be  letter  perfect  in  making  out  time 
tickets,  etc.  It  is  more  likely  that  they 
will  be,  in  lines  where  it  is  possible  to  put 
all  work  through  on  coupon  tickets,  because 
here  the  clerical  work  is  all  done  for  them, 
and  their  only  part  in  it  consists  in  remov- 
ing and  retaining  until  payday  the  priced 
coupon  which  represents  their  various  opera- 
tions and  the  agreed  compensation  therefor. 
Even  where  the  coupon  system  is  not  feas- 
ible, but  where  all  work  goes  through  from 
the  issue  of  material  to  the  completion  of 
the  salable  article,  the  records  can  be  made 
'^y  "  jot)  numbers  "  and  the  character  of 
each  workman's  operation  is  of  compara- 
tively small  consequence.  Where  necessi- 
ties of  economical  administration  require  the 
manufacture  and  stocking  of  many  parts 
the  problem  becomes  much  more  compli- 
cated, and  the  importance  of  close  'connec- 
tion, both  in  point  of  time  and  of  co-opera- 
tion, between  the  pay-roll  distribution  and 
the  recording  of  prime  cost  items  according 
to  product,  becomes  very  great. 

The    pay-roll    distribution    consists    of 
segregating  all  items  of  labour  paid  for 


136  Accounting  for  the  Business  Man    . 

according  to  the  classification  demanded  by 
the  arrangement  of  the  expense  accounts, 
and  further,  according  to  departments  in 
case  departmental  accounting  is  followed. 
The  machinery  consists  of  a  large  sheet 
with  a  margin  and  groups  of  two  or  three 
columns — preferably  three.  Each  group  is 
headed  by  the  designation  of  a  department. 
In  the  margin  are  entered  the  names  of  all 
accounts  to  which  labour  is  chargeable,  leav- 
ing such  number  of  lines  for  entries  as 
inspection  and  experience  indicate  to  be 
necessary.  The  three  columns  of  each  de- 
partment or  group  are  headed  direct  labour, 
undetermined  or  unclassified  labour,  and 
general  or  overhead  or  indirect  labour.  The 
original  records  from  which  the  pay-roll — 
or  all  pay-rolls  of  a  period — have  been 
made  up  must  then  be  entered  on  this 
sheet.  The  horizontal  totals  are  made  from 
the  sub-totals  of  the  second  and  third 
columns.  These  are  the  amounts  charge- 
able to  the  various  accounts  and  together 
make  up  the  total  contingent  addition  of 
labour  items.  Column  number  one  is 
totalled    vertically    regardless    of    account 


Principles  ot  Cost  Accounting     137 

names — ^in  fact  these  account  names  have 
nothing  to  do  with  entries  in  this  column; 
and  this  total  is  the  amount  of  direct  labour 
chargeable  to  the  department  whose  designa- 
tion heads  the  group  of  columns.  The  addi- 
tion of  the  horizontal  and  vertical  totals 
should  equal  the  pay-rolls  distributed.    The 


Department  desiguation 

Accoant 
Names 

Accoant 
Totals 

Direct 

Undeter- 
mined 

Indirect 

Repeat 

to  do 
foot- 
rthe 

2| 

n 

n 

a 

a  *» 

s 

a  « 

^ 

bo-S^S 

B    M 

S  ^. 

«■§  *H 

-^    O 

Q 

so 

CJ 

pl 

r^ 

* 

!: 

.2  « 

CD    3j 

9  c^- 

a  3  _  a 

=  8^2 

X.  acct.s 

This  CO 
with  ac 
ing  is  t 
departn 

00 

00 

00 

00 

00 

00 

object  of  the  undetermined  columns  is  to 
prevent  the  burying  of  items  about  which 
there  may  be  doubt  in  the  mind  of  the 
pay-roll  department.  This  brings  these 
items  into  the  open  to  be  studied  and 
gradually  forced  into  one  of  the  other 
columns.  Ideally  there  should  be  no  entries 
in  this  column.    Those  which  do  occur  must 


138  Accounting  for  the  Business  Man 

go  with  the  indirect  labour  until  they  can 
be  so  organised  that  their  treatment  by  the 
cost  department  becomes  possible.  In  other 
words,  they  must  be  made  chargeable  to 
certain  definite  jobs. 

Past  pay-roll  or  pay-rolls  have  been 
charged,  when  checks  were  drawn,  to  pay- 
roll account,  in  the  asset  and  liabiUty 
ledger,  and  unpaid  pay-rolls  will  also  be 
so  charged.  From  the  pay-roll  distribu- 
tion sheet  just  described,  the  grand  total 
is  credited,  through  the  adjusting  entry- 
book,  to  pay-roll  account,  and  the  horizon- 
tal totals  are  charged  to  the  proper  general 
expense  accounts  by  departments,  while 
the  vertical  footings  of  the  direct  labour 
columns  go  to  the  direct  labour  account  in 
the  expense  ledger,  by  departments.  An- 
other item  not  here  mentioned,  but  which 
often  occurs,  is  labour  on  the  creation  of 
an  asset,  as  a  new  machine,  a  building,  etc. 
Such  items  are  naturally  to  be  segregated 
and  charged  to  the  proper  balance  sheet 
ledger  account. 

Each  ticket  or  item  whose  showing  has 
been   put  into   the   direct   labour   column 


Principles  of  Cost  Accounting     139 

was  put  there  because  it  could  and  should 
be  utilised  by  the  cost  department.  Each 
such  item  is  marked  or  stamped  to  indicate 
its  treatment  and  is  passed  on  to  the  cost 
department  for  use  in  making  its  records. 
These  items  have  been  assembled  twice  al- 
ready, once  according  to  men,  when  the 
workman's  account  was  calculated;  a  sec- 
ond time  according  to  a  threefold  distinc- 
tion, i.e.,  kind  of  labour,  account,  and 
department;  now  it  remains  to  redistribute 
part  of  them — the  direct  labour  items — 
according  to  the  orders  put  through  the 
factory. 

It  has  already  been  stated  that  the  most 
difficult  problem  in  this  connection  arises 
where  necessities  of  economical  operation 
require  the  making  and  stocking  of  quan- 
tities of  parts  to  be  later  assembled  into  the 
finished  product.  We  shall  describe  a  sys- 
tem which  accomphshes  this,  and  whose 
method,  somewhat  simplified,  will  at  once  be 
seen  to  cover  the  simpler  problem.  Let  it 
be  understood  that  this  system  cannot  be 
introduced  to-day  in  an  old  factory,  and 
finished  results  gotten  to-morrow.    On  the 


140  Accounting  for  the  Business  Man 

other  hand  it  must  be  recognised  that  it  is 
based  on  more  scientific  principles,  and  will 
some  day  produce  better  results  than  the 
system  which  involves  the  accumulation  of 
data  from  sundry  sources,  ignoring  lost 
labour,  and  beginning  its  inquiry  long  after 
the  event. 

A  record,  similar  to  a  ledger  account,  is 
opened  for  each  article  or  part,  as  orders 
for  them  may  show  on  the  men's  time- 
tickets.  The  job  or  shop  order  numbers 
on  these  tickets  make  reference  to  a  full 
description  easy.  No  work  is  put  through 
without  such  order.  From  the  order,  par- 
ticulars as  to  quantity,  etc.,  should  be 
entered  in  a  column  provided  for  the  pur- 
pose at  one  side  of  the  sheet.  The  balance 
of  the  sheet  is  given  to  columns  for  the 
recording  of  the  various  operations  on  this 
ordered  article  as  such  operations  may 
appear  on  the  men's  records  of  their  work. 
It  is  sometimes  difficult  to  get  men  to  make 
the  desired  record.  Show  them  that  the 
factory  which  best  knows  its  costs  will  keep 
most  of  its  men  at  work  during  a  panic. 

From    the    time-ticket,    in    the    colunin 


Principles  of  Cost  Accounting     141 

headed  by  the  operation  name  which  the 
time-ticket  bears  (or  the  cost  clerk  knows  to 
be  the  operation  of  the  man  in  question), 
enter  quantity  rate — ^time  or  piece — and 
amount.  Eventually  data  will  be  accumu- 
lated which  will  show  variations  in  rates 
paid  for  the  same  operation,  the  difference 
between  totals  ordered  during  a  given 
period  and  totals  completed,  with  informa- 
tion as  to  just  how  many  operations  were 
performed  on  lost  parts. 

The  total  of  parts  actually  stocked  by 
the  warehouseman  should  be  checked 
against  this  record.  When  all  parts  requi- 
site to  assembling  some  finished  article 
shall  have  been  so  accounted  on,  a  similar 
sheet  may  be  used  for  assembling  opera- 
tions, and  the  complete  labour  cost  record 
made  up  from  all,  or  the  warehouseman 
may  carry  the  parts  at  a  price  which  will 
include  the  labour  recorded  on  the  part 
sheets,  and  in  issuing  parts  for  assembhng 
charge  them  to  the  order  in  question  at  that 
price.  In  that  event  the  inventory  accounts 
would  show  material  and  labour  value  of 
parts  in  stock,  and  only  assembhng  opera- 


142  Accounting  for  the  Business  Man 

tions  would  be  charged  in  the  final  summing 
up  of  the  cost  of  the  finished  article.  This 
method  is  preferable  where  a  thorough 
warehousing  system  has  gone  into  opera- 
tion, and  the  saving  in  figuring  inventory 
of  parts  in  stock  is  sometimes  enough  to  pay 
the  expense  of  operating  a  thorough  system. 
The  warehousing  system  consists  of 
crediting  warehouse  inventory  and  charging 
to  shop  or  customer,  as  the  case  may  be, 
all  material  or  goods  issued.  The  return 
of  these  goods  from  shop  enhanced  in  value 
requires  a  corresponding  credit  to  shop,  and 
charge  to  warehouse  inventory.  This  mar- 
gin, less  the  loss  of  material,  is  the  direct 
labour.  Usually  it  is  not  possible  at  this 
point  to  value  and  record  this  enhancement 
of  value  unless  the  labour  cost  system  has 
reached  a  high  starte  of  perfection  (which 
requires  from  one  month  to  three  years). 
In  that  case  the  returned  parts  would  be 
entered  at  the  value  of  the  material  issued, 
less  the  value  of  scrap  returned.  This 
record  becomes  comparatively  simple  after 
a  period  of  operation,  in  many  lines,  while 
in  others  it  is  exceedingly  difficult,  or  even 


Principles  of  Cost  Accounting     143 

impossible,  because  of  the  way  the  material 
cuts,  and  the  unexpected  divergence  of 
quality.  In  such  cases  it  becomes  necessary 
to  place  an  arbitrary  valuation  upon  each 
part,  getting  as  near  to  cost  of  the  whole, 
and  relative  cost  of  each  as  our  best  experi- 
ence permits. 

Various  approximations  of  exact  mathe- 
matical principles  are  necessary  in  working 
toward  ideals.  Accounting  is,  in  many  re- 
spects, a  science  of  tendencies.  It  is  always 
struggUng  to  keep  pace  with  the  changes 
going  on,  particularly  where  it  has  not 
had  a  proper  start  in  the  beginning  of  the 
business.  Mathematical  exactitude  in  cost 
work,  particularly,  is  difficult  of  attain- 
ment, even  when  the  proper  system  is  put 
into  operation  with  the  turning  on  of  the 
power  for  the  first  time. 

Unless  we  have  these  fundamental  prin- 
ciples in  mind,  however,  the  tendency  of 
our  systems  will  be  away  from,  rather  than 
toward,  the  desired  perfection. 


CHAPTER  XI 

DEVISING  OF  SYSTEMS 

KNOWLEDGE  of  fundamental  prin- 
ciples of  accounting  science,  and  some 
familiarity  with  its  practice,  are  indispen- 
sable in  the  work  of  creating  thorough  sys> 
tern.  Sound  analysis  of  conditions,  clear 
perception  of  what  is  most  essential  to  be 
known  about  the  business,  i.e.,  the  form 
which  the  final  results  should  take,  and 
mathematical  logic  in  reasoning,  are 
equally  important.  Given  these  indispen- 
sable quantities  the  best  system  is  that  which 
is  devised  from  the  standpoint  of  intimate 
and  comprehensive  knowledge  of  the  his- 
tory, organisation,  operation,  personnel, 
competition,  strong  and  weak  points,  and 
object  of  the  particular  institution  for  whose 
use  the  system  is  intended. 

System  consists  of  finding  the  best  way 
to  do  a  thing,  and  arranging  to  have  it 

144 


Devising  of  Systems  145 

done  always  in  that  way.  That  system  is 
most  hkely  to  succeed  which  will  cause 
trouble  if  disregarded.  The  argument  is 
often  advanced  against  a  certain  plan,  that 
its  non-observance  in  some  quarter  will  lead 
to  its  failure.  This  is  really  a  forcible 
recommendation.  No  correct  geometrical 
demonstration  was  ever  developed  from  a 
figure  one  of  whose  essential  Unes  had  been 
carelessly  omitted,  and  no  mathematician 
introduces  into  a  figure  negligible  lines  as  a 
precaution. 

Therefore  it  is  desirable,  and  frequently 
essential,  that  a  system  should  be  put  forth 
with  the  sanction  of  the  highest  authority. 
The  general  manager  should  be  the  system 
man.  He  may  call  in  outside  help — experi- 
enced accountants,  in  order  to  get  the  bene- 
fit of  their  technical  knowledge;  he  should 
invariably  hold  conferences  between  heads 
of  departments  on  the  various  features  of 
a  far-reaching  matter  Uke  an  accounting 
system;  and  he  strengthens  the  sanction  of 
his  own  authority  by  laying  the  structure  of 
a  proposed  plan  clearly  before  the  auditing 
committee  of  the  board  of  directors.     On 


146  Accounting  for  the  Business  Man 

this  basis  system  becomes  business  manage- 
ment, and  management  becomes  systematic. 
The  invariable  result  is  advancement  in  the 
scope  of  the  business,  coupled  with  economy 
in  its  operation. 

All  correct  system  radiates  from  and  is 
governed,  directly  or  indirectly,  by  a  proper 
general  accounting  system,  and  should  fol- 
low it  in  point  of  time.  This,  as  we  have 
already  seen,  is  especially  true  of  cost  ac- 
counting. 

The  steps,  in  their  logical  order,  toward 
the  establishment  of  a  sound  accounting 
system,  are  given  as  expUcitly  as  possible 
in  so  general  a  discussion.  It  must  be 
clearly  understood  that  many  of  the  most 
desirable  results  can  be  obtained  only  by 
the  lapse  of  time  during  which  the  process 
of  development  must  be  persistently  and 
intelligently  fostered.  A  few  weeks'  or 
months'  services  of  an  outside  expert  who 
then  drops  out  entirely  will  not  in  most 
cases  result  in  anytliing  but  failure  and  dis- 
couragement. Some  one  permanently  con- 
nected with  the  business  must  be  the  system 
man.    Management  through  system  is  the 


Devising  of  Systems  147 

only  scientific  method,  and  produces  the 
best  results,  except  in  the  case  of  the  occa- 
sional genius. 

In  the  beginning,  study  the  transactions 
and  processes  of  the  business  with  a  view 
to  two  considerations:  first,  the  form  in 
which  they  can  most  readily  be  assembled 
and  compared  in  balance  sheet  and  com- 
parative charts,  which  shall  be  helpful  to 
the  management  in  improving  the  hold 
of  the  business  upon  its  field;  and,  second, 
the  best  and  easiest  manner  of  recording 
these  matters  in  books  of  original  entry 
so  arranged  that  a  ledger  system  will  natu- 
rally follow,  from  which  such  balance  sheet 
and  comparative  charts  will  be  easily 
created. 

If  the  field  of  operation  is  the  purchase 
and  resale  in  a  limited  market  of  a  narrow 
line,  at  fixed  buying  and  selhng  prices,  the 
problem  is  simple,  and  very  simple  rec- 
ords will  suffice.  The  main  consideration 
limits  itself  to  the  largest  possible  volume 
of  gross  sales,  with  a  minimum  of  general 
expense.  No  cost  system,  beyond  a  close 
analysis  of  general  expenses,  is  necessary. 


148  Accounting  for  the  Business  Man 

and  clerical  work  should  be  reduced  to 
approximately  0. 

Any  deviation  from  the  hypothetical  con- 
ditions above  outlined  will  introduce  com- 
plications, whose  treatment,  in  order  of 
their  bearing  upon  results,  becomes  the 
vital  purpose  of  the  system.  To  illus- 
trate this,  take  the  terms  of  the  simple 
formula,  elaborate  each  in  turn,  and  the 
effect  will  be  seen. 

Purchasing  at  fixed  prices  calls  for  no 
record  beyond  that  of  volume  and  is  an 
operation  safely  left  to  the  office  boy.  This 
function  may  become  the  vital  element  of 
success  or  failure,  however,  and  its  impor- 
tance varies  with  the  complexities  of  source, 
quality,  price,  price  fluctuations,  volume 
and  seasonableness  of  supply,  and  variety 
of  lines.  In  a  business  whose  chief  opera- 
tion is  the  assembling  of  parts  and  material 
made  and  sold  by  many  concerns,  this  func- 
tion and  the  necessary  records  call  for  first 
consideration. 

An  inventory  ledger,  operated  by  the  pur- 
chasing departmerft,  and  showing  full  detail 
of  each  purchase,  may  sometimes  be  used  to 


Devising  of  Systems  149 

advantage.  The  books  of  original  entry- 
should  be  carefully  elaborated — especially 
the  record  of  purchases  and  of  payments 
therefor,  and  the  balance  sheet  should  be 
supplemented  by  a  statement  from  this 
ledger  showing  quantities,  average  costs, 
and  present  valuations.  In  addition  com- 
parative charts  should  be  maintained  on 
price,  and  on  quantity  carried  and  used. 
The  expense  of  these  refinements  is  infini- 
tesimal compared  with  the  risk  of  loose 
buying. 

Selling  against  close  competitive  prices 
also  comphcates  matters.  Costs  at  once 
become  imperative,  particularly  detail 
costs,  and  careful  subdivision  of  contingent 
addition  into  classes  according  to  variation 
with  volume  of  output.  In  no  other  way 
can  we  be  sure  of  keeping  pace  with  com- 
petitors, or  going  out  of  business  before 
losses  become  inevitable  rather  than  after 
they  occur.  Complexities  of  line  and 
process  enhance  the  difficulties,  and  render 
careful  records  vitally  important.  A  con- 
cern having  a  varied  line  and  knowing  its 
costs  may  live  on  certain  lines  while  fight- 


150  Accounting  for  the  Business  Man 

ing  unfair  competition  aggressively  on 
others.  Without  detail  and  department 
costs,  however,  this  is  a  dangerous  under- 
taking. 

If  the  market  be  unlimited  the  problem 
becomes  one  of  organisation  and  resources. 
Expansion  beyond  the  limits  of  one  or 
other  of  these  elements  has  been  a  frequent 
cause  of  disaster.  From  the  accounting 
standpoint  the  frequent  illuminating  bal- 
ance sheet  and  an  accurate  and  provable 
cost  system  are  the  first  essentials,  because 
these  are,  or  should  be,  the  levers  by  means 
of  which  fresh  capital  and  bank  loans  are 
to  be  secured.  Sellings  costs — ^the  whole 
group  of  selling  expenses — should  be  care- 
fully and  frequently  analysed.  Subsidiary 
systems  for  collections  and  price  compari- 
sons are  also  important — the  one  to  prevent 
allowing  needed  capital  to  lie  idle,  the  other 
to  hmit  sales  according  to  territories  or 
other  divisions  where  the  best  prices  can  be 
had.  The  disproportionate  investment  of 
capital  in  various  goods  or  materials  must 
also  be  watched.  Every  cent  of  capital 
must  be  kept  at  work,  even  at  the  expense 


Devising  of  Systems  151 

of  slight  differences  in  price  on  large  and 
small  quantity  purchases. 

The  conditions  must  be  carefully  studied. 
The  next  consideration  is  the  character  of 
the  transactions.  If  there  be  a  large  num- 
ber of  small  transactions,  the  work  of  each 
must  be  as  simple  and  easy  as  possible, 
consistently  with  careful  handhng,  and 
everything  else  must  be  organised  in  such 
a  way  as  not  to  interfere  v^th  the  ma- 
chinery of  selling.  If  the  transactions 
are  individually  large,  then  careful  analysis 
of  each  is  imperative,  and  the  records  can, 
and  usually  should,  be  elaborated  on  each 
transaction,  in  order  to  make  sure  of  proper 
handling.  In  such  a  business,  losses,  when 
they  occur,  are  likely  to  be  of  considerable 
consequence.  Every  business  man  is  fa- 
miliar with  all  these  facts.  They  have  been 
dwelt  upon  here  in  order  to  emphasise  the 
importance  of  considering  them  in  the  work 
of  devising  an  accounting  system.  A  well- 
rounded  system  is  not  likely  to  result  from 
work  begun  before  analysis  along  these 
lines. 

Let  us  suppose  that  we  are  to  create  an 


152  Accounting  for  the  Business  Man 

accounting  system  on  a  fairly  complicated 
business,  where  the  bujdng,  the  competition 
in  selling,  the  possibilities  of  expansion,  and 
the  necessity  of  manufacturing  parts  rather 
than  completed  articles,  all  add  complexity 
to  the  problem.  In  addition,  we  have  sev- 
eral departments,  classifying  by  character 
of  product,  each  line  of  goods  mainly  manu- 
factured in  its  own  operating  department, 
but  getting  some  work  and  materials  from 
other  departments  and  from  sub-operating 
departments,  such  as  plating,  polishing, 
foundry,  tool  shop,  etc. 

We  learn  that  resources  and  credit  of  the 
concern  insure  a  continuance  of  operations 
on  a  cash  basis,  therefore  the  purchase 
record  can  be  made  as  already  described, 
but  with  the  addition  on  the  right  side  of 
a  column  for  entering  the  amounts  of 
checks  drawn  and  another  column  or  two 
for  deductions,  as  cash  discount.  On  the 
left  an  additional  column  must  be  intro- 
duced for  the  total  of  check  plus  deduc- 
tion. :.  There  is  no  particular  reason  in  this 
case  for  carrying  individual  ledger  accounts 
with  our  creditors,  and  there  are  never  very 


Devising  of  Systems  158 

many  unpaid  bills.  If  we  desire  to  know 
the  details  of  an  account  they  can  be  made 
up  from  files  of  paid  bills.  Entries  from 
time  to  time  directly  into  the  governing 
ledger  from  the  right-hand  column  showing 
total  credited  to  purchase  account  when  the 
bills  were  entered,  and  from  the  left-hand 
column  showing  the  total  of  check  plus  de- 
ductions, will  create  an  account  showing  the 
total  of  unpaid  bills  at  any  time. 

An  ordinary  check  register  or  cash  paid 
book,  with  or  without  the  checkbook,  will 
provide  for  other  payments. 

The  sales  record  is  the  next  considera- 
tion. We  find  that  the  orders  are  of 
enough  consequence  to  warrant  copying 
and  filing  in  a  loose  leaf  form.  By  making 
them  in  duphcate,  filing  one  chronologically 
as  an  index  and  the  other  in  two  binders, 
one  for  unfilled  orders  and  the  second  for 
filled  orders,  as  filled,  together  with  copy 
of  invoice,  we  have  an  excellent  means  of 
full  information,  and  the  last  of  the  three 
may  be  used  to  post  the  receivable  ledger. 

All  we  need  is  a  sheet  for  recapitula- 
tions.    This  can  be  ruled  with  a  column 


154}  Accounting  for  the  Business  Man 

on  the  right  for  each  revenue  department, 
and  for  sundry  credits,  or  a  separate 
column  for  each  ledger,  i.e.,  inventory, 
expense,  and  governing.  The  left  is  pro- 
vided with  these  sundry  columns  also  in 
addition  to  the  columns  necessary  to  provide 
for  the  divisions  of  the  sales  ledgers. 

A  cash  received  book  on  similar  prin- 
ciples, that  is,  providing  for  receipts  from 
the  various  divisions  of  the  sales  ledger,  and 
with  sundry  columns  for  the  other  ledgers, 
together  with  an  ordinary  petty  cash  book, 
will  meet  the  requirements,  so  far  as  books 
of  original  entry  are  concerned.  Their 
form  is  a  matter  of  convenience,  not  of 
paramount  necessity,  and  any  competent 
accountant  can  devise  forms  that  will  meet 
the  requirements.  On  the  other  hand,  two 
establishments,  even  in  the  same  line,  can 
seldom  use  each  other's  forms.  A  journal 
for  adjusting  entries  will  be  required. 

Our  ledger  system  will  consist  of  ac- 
counts receivable,  inventory,  expense,  and 
revenue;  all  controlled  by  the  asset  and 
liability  governing  ledger  as  already  de- 
scribed.   There  is  nothing  difficult  or  mys- 


De\ising  of  Systems  155 

terious  about  any  of  these  books.  The  sub- 
sidiary ledgers  get  their  information  from 
the  separate  entries,  the  governing  ledger 
from  the  footings  and  recapitulations  of 
columns,  except  those  entries  which  affect 
asset  and  liability  accounts,  which  come  di- 
rectly from  the  governing  or  asset  and 
liability  ledger  columns  in  the  books  of 
original  entry. 

An  excellent  device  is  a  book  with  a  right 
and  a  left  column  for  each  ledger  system, 
and  a  space  for  particulars  in  the  middle  of 
the  page.  Put  the  asset  and  liability 
ledger  columns  next  this  space  and  the 
others  in  order  desired.  When  the  month's 
work  is  completed  in  any  book  of  original 
entry,  copy  the  column  footings  or  recapi- 
tulations into  this  "  summary  journal," 
putting  the  asset  and  Uability  entries  in 
in  detail.  The  reserve  entries  are  made 
directly  in  this  book.  The  result  is  a  sum- 
mary of  the  month's  business  on  one  page, 
which  must  balance  before  posting  to  the 
asset  and  liability  ledger.  Reserve  entries 
are  posted  directly  to  expense  accounts  from 
this  book.     If  the  opening  balance  sheet 


156  Accounting  for  the  Business  Man 

be  copied  on  the  first  page  of  this  book, 
the  transactions,  in  gross,  of  the  business 
can  be  traced  for  many  years  without  refer- 
ence to  other  sources,  even  though  all  other 
records  should  be  destroyed. 

The  facts  and  conditions  will  readily  sug- 
gest forms  for  the  ledger,  in  the  light  of 
what  has  already  been  said.  The  pay-roll 
distribution  should  be  begun  at  once  and 
all  material  should  be  locked  up  and  issued! 
and  recorded  as  wanted.  Tliis  much  must 
be  done  at  once,  and  may  be  done  without 
the  use  of  a  single  specially  ruled  form 
until  such  time  as  forms  can  be  gotten. 
There  is  no  excuse  for  allowing  careless  or 
ignorant  methods   to   continue. 

A  good  beginning  has  been  made  when 
this  much  is  done,  and  it  will  be  well  to 
turn  the  attention  to  the  perfection  of  these 
features  before  attempting  to  go  farther. 
Formulge  for  the  distribution  of  expense 
groups  and  accounts  must  be  found,  how- 
ever, before  the  results  accounts  can  be 
started,  but  it  is  not  a  very  serious  mat- 
ter if  this  be  not  done  for  some  months* 
The  great  thing  is  to  alternate  stages  oi 


Devising  of  Systems  157 

creating  and  perfecting  what  has  been 
started. 

Shop  order  systems,  time  tickets,  col- 
lections, handling  of  unfilled  orders,  an 
inventory  system,  administration  of  machin- 
ery, sales  data,  and  many  other  things  have 
a  bearing  upon  the  accounting  system  and 
are  influenced  in  their  turn  by  it.  The 
perfection  of  the  one  is  impossible  without 
due  attention  to  the  others,  and  a  cost 
system  as  a  basis  of  price  is  a  very  dan- 
gerous thing  until  a  period  of  experience 
shall  have  made  possible  a  certain  degree 
of  confidence  in  its  accuracy. 

The  general  accounting  system  is  the 
beginning  of  all  systems,  but  there  is  no 
ending  to  any  of  them. 


CHAPTER  XII 

STATEMENT    OF    RESULTS 

THE  form  of  balance  sheet  most  fre- 
quently used  shows  the  figures  at 
which  the  assets  and  liabilities  appear  on 
the  books  at  the  end  of  the  fiscal  year,  and 
a  balancing  item,  on  one  side  or  the  other, 
called  loss  and  gain  or  some  similar  title,  as. 

Cash  $11,000  Accounts  Payable..   $20,000 

Acounts  Receivable .     45,000      Bonds  80,000 

Notes  Receivable.  . .       7,000      Notes  Payable    18,000 

Plant    100,000      Capital   Stock    150,000 

Machinery 51,000      Loss  and  Gain 36,000 

Merchandise    90,000  

$304,000 

$304,000 

This  statement  shows  nothing  beyond  the 
valuations  at  which  assets  and  liabilities  are 
carried  on  the  ledger,  and  the  amount  by 
which  the  ratio  between  them  has  changed 
since  the  books  were  opened.  The  period 
may  have  been  one  year  or  twenty,   and 

168 


Statement  of  Results  159 

therefore  nothing  appears  indicative  of  the 
year's  results  without  reference  to  the  "  loss 
and  gain  "  account  in  the  ledger.  The  in- 
formation given  may  be  all  that  the  man- 
agement desires  to  give,  but  it  is  not  all 
that  those  interested  should  have  or  can  get. 
Bank  loans  are  frequently  made  on  a  report 
of  this  character.  From  the  credit  stand- 
point, only  one  of  the  two  vitally  essential 
elements  appears,  and  that  is  not  as  fully 
expressed  as  might  be.  In  other  words, 
valuations  are  given  without  evidence  that 
they  represent  values.  Progress  or  retro- 
gression at  the  moment  is  not  even  sug- 
gested. The  loss  and  gain  item  may  have 
been  much  larger  before  the  operations 
of  the  year  to  which  this  statement  re- 
fers. The  concern  may  have  lost  money 
for  several  years.  Valuations  and  val- 
ues become  rapidly  divergent  in  such 
cases. 

The  balance  sheet  can  be  made  in  such 
form  that  no  knowledge  of  accounting 
usages  is  necessary  to  enable  any  one  in- 
terested to  derive  the  following  informa- 
tion from  it,  in  addition  to   all  that  the 


160    Accounting  for  the  Business  Man 

other  one  shows  without  reference  to  any- 
other  source. 

1.  Prime  value  of  each  asset. 

2.  Volume  and  rate  of  reserve  against 
each  asset. 

3.  Comparison  of  quick  assets  and  liabili- 
ties. 

4.  Surplus  or  deficit  at  beginning  of 
year. 

5.  Dividend  voted,  whether  paid  or 
not. 

6.  Gains  or  losses  maturing  during 
current  year  but  belonging  to  previous 
period. 

7.  Actual  results  of  current  year. 

8.  Change  in  condition  of  each  asset  and 
liability  account,  which  changes,  taken  to- 
gether, make  up  the  results  of  the  year's 
operations. 

A  statement  of  department  results  ac- 
counts for  the  year  will  explain  the  sources 
of  the  total  result  as  shown  in  this  balance 
sheet,  and  a  list  of  the  accounts  from  the 
expense  and  revenue  ledger  will  give  the 
expenses  in  detail  for  the  whole  business. 
This  statement  will  also  show  the  same  bal- 


Statement  of  Results  161 

ance  as  the  balance  sheet  shows  for  the 
year's  result.  No  further  description  of  this 
statement  seems  necessary.  It  is  self- 
explanatory,  but  requires  careful  study. 
One  point  only  may  be  a  Uttle  confusing  to 
the  beginner.  Why  are  the  two  items, 
dividend  paid,  and  previous  period's  ex- 
penses, included  in  the  column  headed  im- 
provement, and  nowhere  else?  They  are 
included  in  that  column  because  they  have 
come  out  of  the  values  of  the  assets  during 
the  year,  and  yet  they  do  not  belong  to  the 
year,  therefore  in  computing  the  changes 
of  those  assets  as  affected  by  the  year's 
operations  strictly,  we  must  add  them  in 
with  what  the  books  show  those  assets  to 
be.  Otherwise  the  favourable  changes  in 
assets  would  appear  less  than  they  actually 
were  by  the  amounts  deducted  therefrom 
to  pay  dividends,  and  old  expenses.  These 
items,  ought  not  to  appear  as  expenses  of 
the  year,  but  ought  to  be  taken  out  after 
the  margin  between  revenue  and  expense 
has  been  calculated.  The  proper  percent- 
age of  items  of  last  year  should,  of  course, 
be  deducted  from  the  profit  percentage  or 


162     Accounting  for  the  Business  Man 


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Statement  of  Results  163 

commission  of  a  manager  who  was  paid  a 
commission  on  last  year's  profits. 

There  is  no  better  method  for  watching 
the  year's  operations  month  by  month  than 
an  extension  of  this  same  principle.  Rule 
a  large  sheet  with  thirteen  sets  of  two 
money  columns.  Head  the  sets  with  the 
months  of  the  fiscal  year,  in  order,  leaving 
the  first  set  for  the  new  balance  sheet.  In 
the  first  column  of  the  first  month  enter 
assets  in  black  and  liabilities  in  red  oppo- 
site the  balance  sheet  account  correspond- 
ing. In  the  second  column  enter  the 
changes  that  have  occurred,  improvements 
in  black  and  impairments  in  red.  The  dif- 
ference between  black  and  red  in  this 
column  will  be  the  gain  or  loss  for  the 
month,  providing,  of  course,  the  inventory 
be  carried  in  a  current  account,  or  be  ap- 
proximated as  already  explained.  Results 
accounts,  or  detail  expenses  and  revenues, 
can  be  added  in  the  proper  columns  below 
the  balance  sheet  accounts.  Their  balance 
will  check  the  above,  and  their  detail  will 
explain  it.  This  statement  will  be  found 
the  best  of  all  methods  of  watching  the 


164     Accounting  for  the  Business  Man 

operations    of    a    business    as    shown    by 
figures. 

There  is  another  and  much  more  graphic 
manner,  however,  of  showing  results.  It 
consists  of  hne  charts.  Comparisons  can 
be  made  and  watched  better  in  this  way 
than  in  any  other.  Suppose  it  be  the  desire 
to  compare  department  sales  month  by 
month  and  day  by  day,  each  department 
with  its  own  record  for  other  months,  and 
each  with  the  others.  Take  a  large  sheet  of 
paper,  ruled  in  small  squares,  allow  the 
horizontal  dimension  of  the  square  for  the 
lapse  of  a  day,  and  the  perpendicular  di- 
mension of  the  square  for  the  sale  of  a 
certain  amount  of  goods,  as  one  hundred 
dollars.  The  sale  of  one  hundred'  dollars' 
worth  of  goods  in  one  day  would  be  indi- 
cated by  a  diagonal  line  from  the  lower 
left-hand  corner  of  one  square  to  the  upper 
right-hand  corner  of  the  same  square.  The 
next  day  must  carry  the  line  horizontally 
across  the  next  square,  if  it  be  a  working 
day,  and  the  volume  of  the  sale  would  de- 
termine the  height  to  which  the  line  would 
rise. 


Statement  of  Results  165 


Several  departments  can  be  shown  on  one 
chart,  giving  the  second  a  starting  place 
several  squares  to  the  right  of  the  first,  etc. 
Use  different  colours  of  ink  or  pencil,  or 
a  different  kind  of  line  for  each  month  and 
at  the  end  of  the  year  there  will  be  twelve 
lines  starting  at  the  same  point,  for  each 
department  and  running  across  as  many 
days  horizontally  as  there  are  working  days 
in  each,  and  each  line  will  rise  as  high  as  the 


166     Accounting  for  the  Business  Man 

total  sales  for  the  month  will  carry  it.  By, 
having  several  departments  on  one  sheet, 
they  can  readily  be  compared  with  each 
other. 

Almost  anything  from  prices  to  weather 
can  be  compared  on  these  charts.  A  good 
line  to  add  to  the  chart  above  described  is 
a  line  for  each  department  for  the  day  or 
month  representing  cost  of  goods  sold  plus 
department  expense.  Comparing  sales  with 
this  line  we  have  the  profit.  Comparisons 
are  made  vertically,  of  course,  on  the  line 
representing  the  end  of  the  corresponding 
day.  A  little  practice  will  render  this  chart- 
ing system  almost  invaluable,  and  particu- 
larly so  as  the  accounting  system  gets  on  a 
basis  where  its  showings  are  reliable. 

Many  good  comparisons,  as  of  expenses 
in  gross  and  in  detail,  can  be  had  over  a 
long  period  of  time  by  allowing  the  hori- 
zontal dimension  of  a  square  for  a  month, 
thus  letting  the  whole  line  mean  a  year's 
figures.  Comparing  these  year  by  year, 
and  comparing  volume  of  business  in  the 
same  way,  gives  a  better  idea  of  tendencies, 
and  a  much  more  graphic  picture  than  can 


statement  of  Results  167 

be  gotten  by  ranging  figures  in  rows.  Fur- 
thermore it  makes  possible  the  comparison 
of  several  different  matters  with  each  other. 

The  manager  can  make  the  books  and 
statements  therefrom  tell  liim  almost  any- 
thing he  may  want  to  know  about  the  busi- 
ness. These  charts  require  little  time,  and 
the  work  can  be  done  by  an  assistant. 

The  remaining  two  chapters  will  be  de- 
voted to  suggestions  covering  some  of  the 
features  and  matters  of  accounting  and  sys- 
tem which  will  be  found  to  be  helpful  to 
managers  and  to  directors  in  the  perform- 
ance of  their  duties. 

It  is  impossible  to  resist  the  impulse  to 
say,  in  closing  this  chapter,  that  if  every 
business  institution  in  this  country  had  a 
thorough  accounting  system,  and  if  the 
banks,  constituting  the  various  more  or  less 
formal  clearing  house  associations,  had  on 
file,  from  all  such  institutions,  balance 
sheets,  year  by  year  like  the  one  recom- 
mended in  this  chapter,  a  long  stride  would 
have  been  taken  toward  a  foundation  on 
which  to  build  a  currency  system.  We 
business  men  demand  a  currency  system 


168     Accounting  for  the  Business  Man 

from  government  or  the  banks,  without 
realising  that  it  is  largely  our  own  fault, 
in  the  conduct  of  our  own  affairs,  that  we 
do  not  get  it.  It  can  never  come  without 
further  progress  in  this  direction,  and  until 
a  genuine  showing,  not  only  of  values,  but 
of  progress,  is  made  in  the  statements  to 
banks,  we  can  not  blame  them  if  they  prefer 
to  make  their  loans  on  stock  exchange  col- 
lateral— particularly  as  such  loans  act  as  a 
safety  valve  for  them,  on  our  inelastic  cur- 
rency. 


CHAPTER  XIII 

ACCOUNTS  AND   THE   MANAGER 

THE  accounting  system  and  methods 
become  particularly  interesting  to  the 
active  manager,  if  his  contract  provides 
for  a  percentage  of  the  profits.  In  this 
case  there  should  be  a  provision  regarding 
the  basis  on  which  inventories  are  to  be 
made,  and  particularly  if  the  enterprise  be 
an  old  one.  It  is  obviously  desirable,  from 
the  standpoint  of  business  stabiHty,  to  have 
the  inventories  low  in  order  to  keep  the 
working  capital  in  the  business.  Every 
move  toward  conservatism  is,  however,  a 
means  of  reducing  the  manager's  percent- 
age.   There  should  be  no  conflict. 

Having  settled  these  points,  and  taken 
charge,  the  first  essential  is  to  get  a  grasp 
of  existing  conditions.  How  do  the  lines 
of  responsibility  and  effectiveness  lie  as 
between  the  men  in  important  position.    In 

169 


170     Accounting  for  the  Business  Man 

an  old  business  names  of  positions  are  apt 
to  signify  little.  The  strength  and  weak- 
ness of  the  individuals  is  what  counts.  An 
instance  of  this  is  a  factory  where,  until 
recently,  the  shipping  clerk,  a  man  who  had 
grown  grey  in  that  office,  was  the  most 
forcible  man  in  the  organisation.  The 
orders  of  superintendent,  foreman,  and  even 
of  the  manager,  meant  nothing  to  the  work- 
men when  they  saw  a  look  of  determination 
on  the  face  of  this  individual.  Obviously 
three  courses  were  open  to  the  new  man- 
ager, (a)  reorganise  the  individual  to  suit 
his  proper  prerogatives.  This  failed;  (b) 
discharge  him.  This  was  distasteful  because 
of  the  man's  long  services  and  small  chance 
of  other  employment;  (c)  make  him  super- 
intendent. This  was  tried,  but  he  was  so 
little  used  to  authority  rightfully  exercised 
that  this  failed  also. 

Every  feature  of  the  work  and  every 
individual  must  be  under  some  one's  au- 
thority, and  the  lines  must  run  directly 
from  one  end  to  the  other  of  the  organisa- 
tion. After  getting  a  grasp  of  this  task, 
for  it  is  frequently  a  long  operation,  the 


Accounts  and  the  Manager        171 

next  step  is  a  survey  of  the  sales,  including 
the  attitude  of  the  trade.  For  this  pur- 
pose there  is  nothing  so  effective  as  a  trip 
through  a  territory  where  the  business  is 
less  than  it  should  be.  This,  of  course, 
applies  only  to  distributing  and  manufac- 
turing. There  are  analogous  measures  in 
enterprises  of  another  character.  The  rela- 
tion of  product  and  demand  should  be 
carefully  studied  during  this  period,  both 
as  to  character  and  quantity. 

Then  comes  the  work  outlined  in  Chapter 
XI,  and  in  this  work  it  is  usually  desirable 
to  have  the  assistance,  in  an  advisory  ca- 
pacity, of  an  outside  accountant.  His 
function  should  be  not  to  devise  and  intro- 
duce an  entire  system  in  a  few  weeks'  time, 
but  to  assist  the  manager,  himself,  in  this 
work,  for  in  no  other  way  can  continuity 
and  permanency  be  assured.  Furthermore, 
a  good  accountant,  with  wide  experience, 
can  be  infinitely  helpful,  during  this  work, 
in  the  solution  of  many  problems  which 
arise  in  other  lines. 

At  the  same  time  an  appraisal  of  plant 
and  machinery  by  a  competent  authority  is 


172     Accounting  for  the  Business  Man 

always  worth  more  than  it  costs,  and  pro- 
vides a  basis  for  the  creation  of  reserves 
on  a  proper  scale.  This  work  should  be 
followed  by  an  expert  study  of  the  ma- 
chinery and  processes  in  use,  compared  with 
the  best  machinery  to  be  had,  and  the  most 
modern  methods.  What  competitors  are 
doing  frequently  throws  much  light  upon 
these  questions.  Intelligent  salesmen  can 
be  very  helpful  here,  and  an  aggressive 
man  from  some  more  active  plant  in  the 
same  or  allied  lines  should  be  found  and 
placed  in  some  such  position  as  assistant 
superintendent  or  tool  department  foreman. 
Frequently  it  happens  that  a  business 
is  standing  still  or  retrograding,  and  the 
manager  thinks  that  he  has  neither  time  or 
money  for  such  work.  It  is  then  that  these 
measures  become  imperative,  and  there  are 
few  enterprises  that  can  not  be  improved 
by  their  adoption.  Let  the  manager  neglect 
routine  if  necessary — some  one  will  attend 
to  it,  and  let  him  find  the  money  some- 
where. The  sale  of  old  stock  from  the  in- 
ventory, or  a  loan  from  the  owners,  will 
sometimes  provide  it.     In  two  years'  time 


Accounts  and  the  Manager        173 

the  improvement  will  add  an  equivalent 
sum,  and  often  much  more  to  the  yearly- 
net  income. 

There  is  no  system  which  will  operate 
as  it  should  without  constant  watching,  and 
in  an  improving  business,  system  improve- 
ment is  necessary.  The  best  method  of 
assuring  observance  of  instructions  and  of 
avoiding  the  overlooking  of  necessary  de- 
velopments, is  the  use  of  a  calendar  vertical 
file,  arranged  with  divisions  for  the  months 
and  days  of  the  year.  Send  out  all  orders 
and  explanations  in  writing,  and  file  copies 
under  dates  when  the  matter  needs  further 
attention,  either  to  make  sure  of  observance 
or  for  more  development.  Many  other 
things  can  go  into  the  same  file,  and  in  this 
way  the  manager  is  enabled  to  review  sys- 
tematically the  work  of  all  departments, 
and  keep  them  all  marching  at  an  even 
pace. 

Some  things  of  periodical  recurrence 
should  also  be  recorded  in  this  file,  as  pre- 
liminary steps  in  the  management  of  in- 
ventory. This  file  becomes  excellent  insur- 
ance to  the  business  of  continuance  under 


174     Accounting  for  the  Business  Man 

changed  management,  of  many  things  which 
might  otherwise  fail  of  observance.  An 
excellent  illustration  is  an  inventory  system 
in  use  in  the  Simmons  Hardware  Company 
of  St.  Louis.  There  are  several  buying 
departments — ten  or  twelve.  The  good* 
are  stored  according  to  bulk  and  other  con- 
siderations, which  result  in  dividing  each 
buying  department's  line  among  several 
warehouses  and  order-filling  departments. 
The  problem  was  to  take  the  inventory 
in  such  a  manner  that  each  buying  depart- 
ment might  have  its  line  in  a  book,  ar- 
ranged for  its  own  convenience,  priced 
beforehand,  and  so  arranged  that  ware- 
house totals  for  insurance  purposes  would 
be  accessible.  Preparations  must  be  com- 
pleted well  in  advance.  The  buyers  must 
list  the  goods  and  indicate  prices  in  books, 
each  page  ruled  with  a  column  for  each 
warehouse.  Count  tickets  must  then  be 
made  from  these  books,  bearing  descrip- 
tion, page  in  buyers'  books,  designation  of 
buying  department,  and  of  warehouse  where 
goods  were  kept  (a  colour  scheme  was  used 
for  this).     These  cards   or  count  tickets 


Accounts  and  the  Manager        175 

must  then  be  distributed  to  the  proper 
warehousemen,  and  by  them  given  out  to 
squads  in  charge  of  sections.  The  count 
was  then  made,  verified,  and  corrected  as 
shipments  in  or  out  occurred  during  the 
days  immediately  preceding  the  inventory. 
On  the  day  appointed  the  count  cards  were 
removed,  rearranged  according  to  buyers' 
books,  and  quantities  entered  opposite 
the  descriptions  which  had  been  previ- 
ously entered,  and  from  which  the  count 
tickets  were  made.  The  plan  was  success- 
ful; and  the  following  year  the  calendar 
file  furnished  timely  instructions  and  sug- 
gestions to  the  successor  of  the  man  who 
put   it   into   operation. 

Machinery  administration  is  another  mat- 
ter which  can  be  car^uUy  watched  in  a 
similar  manner.  Any  thing  which  should 
be  done  or  investigated  at  a  certain  time 
of  the  month  or  year  can  be  assured.  An 
excellent  collection  system  can  be  operated 
in  harmony  with  this  device.  Let  the 
statement  clerk  send  to  the  manager  an 
original  and  carbon  copy  of  all  delinquent 
accounts,  the  original  to  be  mailed  with  a 


176     Accounting  for  the  Business  Man 

first  letter,  the  copy  to  be  held  in  a  special 
file  with  copy  of  letter.  Place  a  memo- 
randum in  the  calendar  file  under  date  on 
which  settlement  should  arrive.  Have  re- 
ports daily  from  ledger  clerk  of  all  settle- 
ments or  delinquent  accounts,  from  which 
reports  notations  can  be  made  on  statement 
and  memorandum  in  calendar  file.  Auto- 
matically these  matters  will  come  up  for 
attention  on  the  proper  day.  If  no  day 
be  set,  the  file  of  statements  can  be  returned 
to  the  ledger  clerk  on  the  first  of  the 
month,  who,  after  sending  out  all  other 
statements,  can  make  a  new  original,  and 
note  any  changes  on  the  old  copy.  A  sec- 
ond letter  can  then  be  sent,  and  by  con- 
tinuing in  this  manner,  no  accounts  can  be 
overlooked. 

In  this  manner,  also,  it  is  possible  to 
follow  closely  the  operation  of  time-ticket 
records  for  use  of  the  cost  department, 
shop-order  systems,  department  transfers 
of  material  and  labour  on  the  inventory 
ledger  and  the  departmentised  expense 
ledger,  and  many  other  matters,  some  of 
which  are  sure  to  be  overlooked  if  memory 


Accounts  and  the  Manager        177 

and  a  convenient  time  be  depended  upon 
entirely.  Salesmen's  route  sheets,  with 
timely  information  as  to  lists  of  customers, 
their  average  volume  of  purchases,  the  sea- 
sonableness  of  goods,  usual  expense  of  the 
trip,  and  incidental  matters  of  interest,  if 
filed  in  this  way,  will  be  found  very  helpful. 

In  addition  to  the  suggestions  already 
made  the  creation  of  certain  charts,  as  ex- 
plained in  the  last  chapter,  will  be  found 
very  profitable. 

It  is  an  excellent  plan  for  the  manager, 
or  his  immediate  assistant,  to  operate  the 
balance  sheet  and  governing  ledger,  and,  if 
possible,  the  expense  and  revenue  ledger. 
Tliis  brings  the  balance  sheet  and  its  show- 
ing into  the  active  Ufe  of  the  business  in  a 
way  that  nothing  else  can  do,  and  it  results 
in  the  operation  of  every  feature  in  a  more 
scientific  manner.  It  also  prevents  the 
establishment  of  a  httle  monarchy  in  the 
accounting  department — a  most  dangerous 
place,  indeed,  for  one  to  exist. 

A  constructive  thinker,  in  control  of  the 
accounts,  can  sometimes  save  an  otherwise 
hopeless   cause.     An   obstructive   thinker. 


178     Accounting  for  the  Business  Man 

with  that  leverage,  can  block  the  wheels  of 
progress;  and  the  wrecker  must  control  the 
accounts  in  order  to  effect  his  purpose  with- 
out discovery. 

It  may  be  objected  that  a  busy  manager 
has  not  the  time  to  carry  out  these  sugges- 
tions. The  answer  is  that  the  manager  who 
has  under  his  own  eye  all  the  systems  con- 
tained in  these  suggestions,  can  safely  leave 
the  other  work  to  the  various  departments, 
and  if  he  be  an  able  executive  he  will  soon 
learn  just  which  parts  of  this  work  to 
delegate  to  his  trained  corps  of  assistants. 


CHAPTER  XIV 

ACCOUNTS   AND   THE  DIRECTORS 

IT  is  generally  conceded  that  our  business 
life,  more  than  that  of  any  other  civil- 
ised nation,  is  subject  to  alternating  periods 
of  exhilaration  and  depression.  This  condi- 
tion results,  aside  from  domestic  uncer- 
tainty, in  making  us  at  one  time  the  cause 
of  considerable  amusement  to  our  neigh- 
bours— ^that  is,  when  we  are  enjoying  over- 
expanded  prosperity;  and  at  the  other  time, 
during  our  undue  depressions,  we  become 
the  source  of  annoyance  and  disturbance  to 
their  more  stable  financial  systems,  by 
creating  extraneous  pressure  upon  their 
safety-valve — the  discount  rate.  We  owe  it 
to  them,  as  well  as  to  ourselves,  to  remove 
the  cause  of  this. 

It  is  true  that  the  rash  abandonment  of 
sound  banking  principles  was  the  primal 

source  of  trouble,  but  the  results  of  that 
I7d 


180    Accounting  for  the  Business  Man 

act  are  conditions  which  the  restoration  of 
a  discount  system,  however  well  planned, 
would  not  alle\aate.  These  conditions 
would  not  have  arisen  under  a  proper  sys- 
tem, but  once  created  they  must  be  dealt 
with  firmly  and  on  right  lines  in  order  to 
make  possible  a  restoration  of  a  proper 
banking  and  currency  system. 

In  other  words,  the  thing  needed  is 
sound  commercial  paper  for  rediscount  as  a 
basis  for  a  currency  whose  elasticity  shall  be 
adequate  to  and  subject  to  our  business 
requirements.  It  is  a  common  complaint 
against  our  banks  that  loans  are  made  only 
on  stock  exchange  security,  regardless  of 
commercial  needs.  This  is  often  true,  but 
the  banks  cannot  be  held  entirely  respon- 
sible for  the  evil.  In  fact,  it  may  often  be 
the  salvation  of  our  structure,  for  we  must 
have  reservoirs  from  which  to  draw  sud- 
denly in  cases  of  dire  necessity.  We  must 
have  some  measure  of  elasticity,  and  under 
present  conditions  commercial  paper  in  the 
hands  of  banks  constitutes  their  slowest 
asset. 
.   The  cause  of  this  is  twofold.    There  is  no 


Accounts  and  the  Directors        181 

macliinery  for  rediscounting  commercial 
paper,  and  the  commercial  paper  is  not 
based  on  a  sufficiently  universal  plan  of 
presentation  and  responsibility.  The  first 
of  these  two  main  causes  will  be  removed  by 
contemporaneous  development  of  the  clear- 
ing house  organisation,  and  of  public  in- 
telligence and  sentiment  for  proper  legis- 
lation in  aid  of  district  clearing  house 
organisations  under  central  supervision.  It 
is  to  be  hoped  that  this  legislation  will 
proceed  step  by  step,  defining  rather  than 
creating,  thus  allowing  natural  and  logical 
development.  The  details  can  safely  be 
left  to  work  themselves  out.  We  are 
the  same  people  in  our  business  organisa- 
tion as  in  our  political  organisation,  but, 
for  many  reasons,  often  wiser  in  the 
former. 

The  second  cause  of  our  financial  unrest 
will  be  removed  only  when  our  commercial 
paper  is  presented  to  banks  for  discount 
with  the  sanction  behind  it  of  a  uniform 
manner  of  valuation  and  accounting,  and 
of  our  more  fixed  and  unavoidable  re- 
sponsibility  of  boards   of   directors.     We 


182     Accounting  for  the  Business  Man 

have  discussed  the  principles  of  accounting 
in  considerabk  detail. 

Of  the  lack  of  responsibility  of  boards  of 
directors  every  business  man  of  wide  ex- 
perience has  personally  observed  glaring 
instances.  The  public  press  has  reported 
many  cases  where,  under  investigation  by 
courts  or  investigating  committees,  directors 
have  been  excused,  on  the  plea  of  ignorance 
of  the  event,  from  responsibility  that  would 
have  rested  heavily  upon  an  individual  or 
a  partnership  conducting  the  same  busi- 
ness. 

It  seems  to  be  generally  conceded  that 
laws  and  law  courts  should  not  compel  men 
to  do  what  is  impossible;  and  it  is  assumed 
that  what  a  director  does  not  know  he  can- 
not know.  Therefore  the  director  is  not 
regarded  as  a  trustee  of  the  property  and 
conduct  of  the  corporation.  He  receives 
little  or  no  compensation,  which  fact  also 
contributes  to  his  relief  from  responsibility, 
and  he  is  not  selected  for  the  position  be- 
cause of  his  known  ability  to  analyse  the 
transactions  of  the  management.  In  vary- 
ing degrees  this  is  different  in  other  coun- 


Accounts  and  the  Directors       183 

tries,  and  it  will  change  with  us  before  our 
financial  system  reaches  its  best  develop- 
ment. 

The  change  will  come  through  the  recog- 
nition of  the  fact  that  with  a  proper 
accounting  system,  properly  audited  by 
competent  board  members,  there  is  little, 
if  anything,  which  the  director  can  not  and 
should  not  know  about  the  transactions  of 
the  week  or  month,  or  even  longer  period 
elapsing  between  meetings.  When  com- 
mercial paper  shall  be  based  upon  an  illumi- 
nating balance  sheet,  which  report  bears  the 
stamp  of  a  responsible  board  of  directors, 
our  banks  will  not  be  behind  those  of  other 
countries  in  recognising  its  superiority  as 
a  basis  for  an  elastic  currency.  Their  dis- 
trict or  clearing  house  organisations  will 
begin,  httle  by  little,  to  act  upon  this  basis, 
and  government  will  be  confronted,  not 
with  a  dark  problem  demanding  solution, 
but  with  a  condition  demanding  definition 
and  support. 

Some  measures  which  will  help  to  enable 
a  board  of  directors  to  meet  this  responsi- 
bility, and  at  the  same  time  further  the 


184     Accounting  for  the  Business  Man 

interests  of  their  enterprise,  are  here  sug- 
gested : 

1.  If  it  be  found  that  no  expert  in 
accounts  has  been  included  in  the  board, 
then  let  one  be  employed  to  act  as  chairman 
of  an  auditing  committee  whose  other  mem- 
bers should  be  directors.  It  is  desirable, 
however,  that  he  be  a  member  of  the  board 
for  the  sake  of  greater  freedom  in  showing 
the  bearing  of  the  records  upon  matters  of 
business  policy. 

2.  With  expert  help,  and  by  careful 
examination,  determine  values  and  create  a 
balance  sheet. 

3.  In  the  light  of  information  upon  which 
valuations  were  based,  determine  basis  of 
revaluation,  i.e.,  depreciations,  etc. 

4.  If  an  accurate  running  inventory  of 
merchandise  or  material  be  even  temporarily 
unavailable,  determine  an  arbitrary  ratio,  as 
already  explained,  for  estimating  consump- 
tion. (This,  together  with  reserves,  car- 
ried month  by  month,  not  only  makes 
approximated  monthly  balance  sheets  pos- 
sible, but  causes  a  uniformity  of  expense 
charge  which  cannot  be  greatly  varied  with- 


Accounts  and  the  Directors        185 

out  causing  comment.  It  also  leads  to 
comment  and  explanation  in  case  the  in- 
ventories, when  taken,  vary  too  much  from 
the  estimate.) 

5.  Make  a  list  of  production  depart- 
ments, and  a  list  of  detail  expense  accounts 
to  be  carried. 

6.  Make  sure  of  the  capacity  of  the  per- 
son responsible  for  the  accounts,  to  arrange 
original  entries  in  such  form  that  the  ledger 
system  will  be  properly  maintained  and  to 
avoid  errors  in  charging  as  between  asset 
and  expense  accounts.  He  should  also 
understand  carrying  inventory  accounts  for 
supply  or  other  expense  outlays  which 
should  be  spread  over  a  period  longer  than 
that  between  the  most  frequent  approxi- 
mated balance  sheets. 

7.  See  the  balance  sheet  entered  in  the 
asset  and  liability  ledger,  and  in  the  first 
set  of  columns  on  the  thirteen-column  bal- 
ance sheet  chart.  Place  the  former  in  the 
hands  of  the  manager,  and  the  latter  under 
lock  and  key,  where  it  will  be  accessible 
only  to  the  auditing  committee.  (This  in 
case   a  very   strict  watch  be   deemed   ad- 


186     Accounting  for  the  Business  Man 

visable,  as  for  the  protection  of  the  man- 
ager from  any  possible  charge  of  inac- 
curacy from  outside  sources,  or  from  a 
minority  interest.)  Use  a  similar  sheet  for 
recording  operation  account  balances  and 
monthly  changes.  A  wonderfully  accurate 
knowledge  of  what  is  going  on  can  be  had 
by  calling  for  the  balances  from  the  ledgers 
and  entering  them  on  these  sheets  at  the 
meetings.  Every  unusual  item  will  then 
have  to  be  explained,  and  if  large,  can  then 
and  there  be  investigated  from  the  original 
documents.  In  some  cases  a  sworn  state- 
ment by  the  manager  regarding  such  a 
matter  would  be  helpful. 

8.  The  matter  of  costs,  and  how  to  record 
them,  should  be  discussed,  and  a  plan  de- 
vised. Contingent  addition,  margin  of 
profit,  market  price,  selling  policy,  and 
selling  organisation  naturally  come  up  for 
discussion  in  this  connection,  and  should 
be  carefully  considered  in  the  light  of 
what  plans  the  management  may  have 
made.  A  definite  plan  which  is  wrong  is 
better  than  none. 

9.  Line  charts  on  sales,  expenses,  product 


Accounts  and  the  Directors       187 

both  by  count  and  valuation,  and  on  such 
other  matters  as  are  vital  should  be  called 
for,  because  of  their  value  in  graphically 
showing  facts  and  still  more  because  of  their 
indication  of  tendencies.  The  promotor  of 
a  new  business  might  well  be  asked  to  chart 
his  estimates  for  later  comparison. 

10.  Give  the  auditing  conmiittee  instruc- 
tions: (a)  To  make  occasional  inspections 
of  the  entries  in  books  of  original  entry, 
and  their  transcription  into  the  summary 
journal,  (b)  To  check  all  or  part  of  the 
statements  mailed  by  creditors  with  their 
ledger  accounts,  or  with  the  records  on  the 
voucher  purchase  journal,  (c)  To  send  out 
sales  ledger  statements  occasionally  with  a 
request  for  confirmation  of  their  accuracy 
to  be  mailed  directly  to  the  auditor,  (d) 
To  inspect  purchase  bills  and  ascertain  the 
correctness  of  the  accounts  to  which  they 
are  charged,  (e)  To  inspect  the  pay-roll 
distribution  as  to  the  correctness  of  charges 
to  accounts  representing  permanent  invest- 
ment, prime  cost  of  product,  and  general 
expense  and  to  make  sure  that  there  are  no 
"  dummies  "  in  the  pay-roll,  and  that  each 


188     Accounting  for  the  Business  Man 

man  actually  receives  the  amount  set  oppo- 
site his  name  in  the  pay-roll  book. 

Other  things  will  be  suggested  from  time 
to  time.  The  physical  inspection  of  in- 
ventories is  a  task  which  varies  inversely  in 
ease  and  importance,  but  a  difficult  in- 
ventory to  inspect  minutely  is  usually  a 
difficult  one  to  mishandle  grossly  if  the 
precautions  above  outhned  be  adopted  in- 
telligently. 

Let  it  be  clearly  understood  that  these 
measures  are  suggested  primarily  in  the 
desire  to  place  the  responsibility  for  the 
conduct  of  the  business  upon  the  highest 
authority.  The  board  of  directors,  under 
the  present  system,  hold  the  power  of  final 
action  in  most  matters;  but  they  do  not 
and  can  not,  in  many  instances,  take  upon 
their  shoulders  the  corresponding  respon- 
sibility. Any  board  may,  and  all  boards 
should,  assume  it,  and  the  law  will  recognise 
this  fact  some  day.  When  that  day  comes, 
perhaps  this  little  book  will  be  found  a 
very  present  help  in  time  of  trouble  in 
quarters  where  trustworthy  advice  may  not 
be  readily  available. 


TBE  C0T7NTRY  LIFS  PRESS 
\OABDENCrrY,  N.  T. 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 
BERKELEY 

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